By Panagiotis Vassiliades
Deputy CEO, MAP Risk Management Services Ltd (MAP RMS)
Pursuant to Article 32 of the European Banking Authority’s (EBA) Funding Regulation, the EBA is required to assess and evaluate market developments, as well as inform EU institutions, bodies and participants about their findings. Therefore, on an annual basis, the EBA issues its Risk Assessment Reports, which aims to provide updates on risks and weaknesses within the EU banking sector, while equipping the EBA with insights regarding the financial sector’s main risks and vulnerabilities.
The July 2024 Risk Assessment Report (RAR) by the EBA offers a comprehensive analysis of the risks and challenges faced by banks in the European Union (EU) and European Economic Area (EEA). The report provides valuable insights into the banking sector’s current situation and outlines key trends, vulnerabilities, and projections for the coming years.
Below is a summary of its key findings:
EU banks face uncertainties
The combination of geopolitical events and ambiguous prospects for economic growth are the key reasons surrounding the uncertainties currently faced by EU banks. Interest rate cuts initiated by several central banks proved to be insufficient to counter the high level of risks and instability.
Reduction in loan growth of EU banks
EU banks that have been impacted by the macroeconomic and monetary conditions have witnessed a negative effect on loan growth, whereas non-performing loans have increased despite net NPL inflows being slightly positive in 2023. Asset quality is expected to stabilise, even improve according to banks’ expectations. Moreover, banks expect to witness growth in household NPLs in coming years, whilst corporate NPLs are projected to skyrocket in 2024 and then progressively stabilise.
Growth in EU banks in loans collateralised by commercial real estate (CRE)
Following growth in recent years, EU banks have more than EUR 1.4tn in loans that are backed up by commercial real estate, a category that accounts for less than 100% of the banks’ capital. Exposures to CRE against non-EEA-domiciled counterparties are vulnerable to market downturns, something that has been evidenced by the rise in NPL volumes in CRE during 2023 (>12%), with some variation between EU member states.
Deposits represent the main source of funding
Alongside longer-term refinancing operation repayments, which were vastly replaced by issued debt securities, funding by central banks reported a reduction during 2023. In spite of increases in issuance volumes, covered bonds and unsecured debt dropped during the first half of 2024 in comparison to last year. Moving along, maturing minimum requirements for own funds and eligible liability instruments will need to be replaced.
Rise in the availability of collateral
According to asset encumbrance data, banks saw an increase in the availability of collateral used for various means of funding in 2023, a move that eases their financial position during stressed conditions in which issued bonds drop or deposits are reduced.
Upcoming increases in long-term market-based funding
2024 is projected to be the year with the highest volume of issued unsecured debt. This shall be particularly noticed for Additional Tier 1 and Tier 2 capital instruments. According to funding plan data, EU banks are planning to increase total long-term market-based funding for the 2024-2026 period.
Liquidity positions, CET 1 levels and Pillar 2 guidance
EU banks’ liquidity coverage ratios are expected to drop in 2024. As for the net stable funding ratio, it is projected to fall in 2024, and then increase again in upcoming years.
In addition, hikes in CET1 ratios and respective requirements increased with banks expecting a further increase in payouts this year.
EU banks increased profitability
EU banks profitability increased in 2023 as a result of a significant rise in year-on-year net interest income, which was backed by a widening net interest margin. Even though net interest income stabilised during 2023, profitability indicators recorded a slight decline, signifying a peak in banks’ profitability. During 2024, banks expect to see increases in loan and deposit rates, especially for loans to and deposits from households and non-financial corporations. According to funding plan data, the variance between client loans and client deposits is not expected to change this year. In addition, and according to banks expectations, a slight increase in costs for market-based funding is projected in 2024 compared to the previous year.
Operational risk significance
Operational risks are becoming increasingly relevant with cybersecurity risks ranking the highest out of all operational risks, followed by conduct, legal, and fraud risks. The EBA Risk Assessment Questionnaire also indicates that sanctions are the most relevant risk relating to money laundering and terrorist financing.
Non-bank financial intermediary activities
During the past decade, the activity of non-bank financial intermediaries has risen substantially in the EU. With this increase, the direct or indirect risk posed to banks increases as well. Direct lending by non-bank financial intermediaries to non-financial sectors has been on the rise given increases in lending volumes. New opportunities have arisen, but so have operational risks and reduced lending standards than those for banks.
Future prospects
The EBA’s report emphasizes that even though the banking sector continues to be resilient, it is operating as part of an uncertain environment. Economic prospects are fragile due to inflation risks, geopolitical uncertainties, and market volatilities affecting banks’ performance. Banks are anticipating these same challenges in 2024 and are preparing for reduced profitability, tighter liquidity, and increasing credit risks. Banks are also expected to increase loan growth and boost capital and funding positions against these future challenges.
Conclusion
The EBA’s Risk Assessment Report summarises the key risks and weakness surrounding the EU banking sector. The takeaways that should be noted are that, although the sector remains stable, various important challenges exist, especially in relation to asset quality, funding, and operational risks. The current geopolitical and economic uncertainties require banks to be prudent and flexible through their approach as they move forward in an unstable operating environment.