The solvency of European banks is improving, along with their profitability and liquidity. The main threat to the sector remains the asset price corrections, noted the European Banking Authority (EBA) in the annual monitoring of the banking system. Bank capital and liquidity positions have improved year on year, along with profitability. However, structural challenges for profitability remain.

Fiscal and regulatory support measures have prevented asset quality deterioration but have also made it more difficult for banks to assess borrower creditworthiness. Uncertainty on the economic outlook could trigger repricing of risks. According to the report, operational risks in the sector have increased, mainly due to IT and cyber risks, requiring banks to further prioritise IT and cyber security.

The survey of EBA covers 120 banks from 25 countries in the EU and European Economic Area. 

It is reassuring that fears about potential asset quality deterioration have not materialised, except for the sectors most affected by the pandemic. Looking ahead, banks as well as micro and macro prudential authorities need to be prepared in case of a deterioration in the economic outlook or in case inflationary pressure translates into further rising rates.

 

Asset quality has improved overall but concerns remain for loans to specific sectors and those that have benefited from support measures. The non-performing loan (NPL) ratio has further decreased to 2.3% this year supported by several large NPL securitisations. However, the NPL ratio of the exposures to the sectors most affected by the pandemic is on an upward trend. The asset quality of loans under public guarantee schemes and under moratoria is a source of concern as an increasing share of these loans are being classified under stage 2 (at a risk of delay) or as NPL (see the chart). 

Accelerating house price increases along with banks’ recent focus on mortgage lending may become a source of vulnerability going forward, noted the EBA. 

Operational risk losses have increased during the pandemic. The growing usage of and reliance on technology has been accompanied by a rising number and impact of information and communication technologies and security-related incidents. 

The European regulator noted further improvement in the bank’s capital and liquidity positions The average Common Equity Tier 1 (CET1) ratio has increased on the back of strong results in the first half of 2021. Although supervisory recommendations on capital distribution have expired, banks should not pursue overly generous dividend and share buy-back policies. Amidst increasing rate volatility, banks should carefully evaluate the risk profile of their funding plans and ensure they are able to substitute current central bank funding with other sources of funding, say the experts of EBA.

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