Banks, EBA: prepare for asset deterioration, caution on dividends

EU banks rate expectations untouched by Ukraine Well positioned

(Finance) – Le European banks “they should prepare for a likely deterioration in asset qualityRising rates could increase debt payments and reduce collateral valuations, while higher inflation and slower economic growth could reduce the disposable income of borrowers. the European Banking Authority (EBA) in its annual risk assessment of the European banking system, adding that banks should “timely recognize vulnerable customers and related write-downs”, “engaging as soon as possible with customers in difficulty to ensure their sustainability”.

Even though banks’ profitability appears to benefit from higher interest rates and capital ratios are at relatively high levels, according to the EBA banks should “carefully consider dividend policies, share repurchases or bonuses“. Prudence is recommended to “cover unexpected losses and maintain the flow of loans to the real economy in a worsening macroeconomic environment”.

The report of the Association is accompanied by the publication of theEU-wide transparency exercise of 2022which provides detailed information, in a comparable and accessible format, for 122 banks in 26 EEA/EU countries.

Concerns about the increase in exposures to the energy sector

The report highlights that increased price volatility in EU oil and gas markets created unprecedented liquidity needs for energy companies earlier this year. The banks are actively engage with energy companies to provide them with a wide range of services to manage volatility in energy derivative markets. As a result, “banks have significantly increased their overall exposures to the sector, both in terms of loans and derivative instruments. These exposures are concentrated in a small number of banks“.

First signs of deterioration in asset quality

NPLs continued to decline and their dispersion across banks narrowed significantly. However, new inflows of NPLs increased markedly in the first half of 2022. The stage 2 loan ratio was “at its highest level since implementation”. Banks increased provisions for performing loans. Nonetheless, the overall cost of risk (CoR) fell below pre-pandemic lows, presumably due to still substantial NPL outflows and the release or reallocation of unused COVID-19 provision overlays.

Financing costs are expected to rise

The EBA highlights that banks “must repay large amounts of central bank loans until 2024″. A number of banks will be able to rely on existing liquidity reserves, including central bank deposits, to repay central bank loans. Some banks, however, “they may have to issue more debt or increase depositsIt remains to be seen how expensive the replacement of central bank funding will be. Even meeting or refinancing the minimum MREL requirements “could prove to be a challenge for some banks.”

It remains uncertain how profitability will evolve

Strong growth in loans and net interest margin (NIM) contributed to an increase in banks’ RoE. With the lifting of pandemic-related restrictions on shareholder remuneration, banks are expected to return to a pay-out ratio of around 50%, in line with the long-term average. The expected macroeconomic deterioration “will likely result in slower loan growth and higher writedowns, while rising inflation could raise operating costs.”

Lower GDP growth and higher rates could also translate into lower fee income from wealth management and payment services. Finally, banks that are more reliant on wholesale funding may face faster increases in funding costs.

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