Vienna Initiative: Pressure on the bank’s assets quality is rising

The impact of the Covid-19 pandemic on bank credit risk among the banks in the European Union (EU) and the broader central, eastern and south-eastern European (CESEE) region has been largely mitigated by the comprehensive government support measures implemented by most countries. As a result, initial fears of a rapid deterioration in asset quality have not yet materialised and nonperforming loan (NPL) stocks are now back on their pre-pandemic downward trend. This is stated in the last report of Vienna Initiative, a think-tank for observing the credit market in CESEE. 

As of 31 December 2021 the NPL ratio in the CESEE region stood at 2.8%, the lowest level in recent years. The region’s NPL coverage ratio has also remained relatively strong at 64.6% as of 31 December 2021. Bulgaria is again among the countries with the highest level of overdue bank loans, more than twice the regional average (see the chart). 

While the immediate impact on financial-sector soundness and bank asset quality in the CESEE region seems moderate and manageable so far, pressures on asset quality are building. Concerns remain that some of the effects of the pandemic on NPLs might, at least in part, be delayed and may still materialise as the benefits of support measures wane. 

Retail banking risks are also a concern as the situation persists, especially with regard to the mortgages of lower-income households, which are likely to be struggling to cope with the erosion of their disposable income. Regulators and banks need to act in a timely manner and take the necessary pre-emptive measures to prevent a new build-up of NPLs and avoid value erosion for banks and borrowers. The experts of VI recommend that banks should have adequate loan origination, monitoring and control policies and processes in place, including robust early-warning identification systems and comprehensive key risk indicators to allow the early identification of borrower stress or distress. 

Loan classification and staging should be accurate, enabling the proper monitoring and evaluation of bank risks, as well as sufficient and timely provisioning, say the experts. According to the report of VI, banks should also be prepared to act swiftly on any new inflows of NPLs, by having all the necessary processes in place to allow early intervention with sustainable measures to support viable and collaborative borrowers where necessary. Preparations in the CESEE region in the coming months will be crucial to avoid repeating the mistakes of the past, noted VI. 

Adding to this is Russia’s war on Ukraine, sparking new risks from faster inflation and geopolitical tensions along the EU border. In the event of a prolonged war, the share of NPLs and stage 2 loans (at a risk of delay) is likely to increase, raising concerns about the potential impact on financial stability. One of the main challenges for banks will be to understand the actual impacts on credit risk associated with second- or third-round effects from the war. This includes not just the various macroeconomic implications, such as inflation and rising energy prices, but also the potential knock-on effects across industries due to rising costs (such as shipping and raw materials) and expected disruptions in supply chains, which might exacerbate the disruptions already triggered by the Covid-19 pandemic. 

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