The European banking industry faces a deteriorating outlook for asset quality and profitability, real estate vulnerabilities and “more aggressive” cyber threats, according to the three European Supervisory Authorities in their Spring 2024 Joint Committee risk assessment.
The European Banking Authority, the European Insurance and Occupational Pensions Authority, and the European Securities and Markets Authority presented the findings on April 30.
The outlook for banks is “challenging” against the backdrop of lower interest income, slower loan growth and high costs, the supervisory authorities said. High net interest margins, driven by strong net interest income, may not be sustainable amid lower interest rates and as banks face pressure from repricing.
Higher interest rates — despite benefiting banks’ profitability margins — also pose medium-term challenges.
“In recent months, financial markets have performed strongly in anticipation of potential interest rate cuts in 2024 in both the EU and the US, despite the significant uncertainty surrounding these. This strong performance entails elevated risks of market corrections linked to unexpected events,” the assessment said.
In the third quarter of last year, bank capital ratios remained strong with a common equity Tier 1 ratio of 15.8 per cent — compared with 14.8 per cent in the same period the previous year — and a liquidity coverage ratio above 160 per cent.
But the outlook is more challenging, the ESAs said. “Banks face the repricing of liabilities and assets with prospects of lower interest income, slower loan growth, high costs and the challenging macro environment,” the assessment said.
Return on assets and return on equity were reported at their highest levels since the global financial crisis, reaching 0.71 per cent and 10.9 per cent, respectively, in the third quarter of 2023, but the ESAs expect higher interest rates to bring medium-term challenges.
Strong interest rate risk management capabilities will prove important in the “uncertain” interest rate environment, the assessment said, given that monetary tightening has increased interest rate risk in banking books, including the impact of rate changes on fixed-rate assets.
Lower demand for lending as a result of higher interest rates may have implications on asset quality amid borrowers’ abilities to service loans, the ESAs added. At present, asset quality is robust, with a low non-performing loan ratio of 1.8 per cent reported in the last three months of 2023, though NPLs are “marginally increasing”.
Banks have tightened their lending standards while demand for loans, including real estate loans, remains weak. “EBA surveys show a lower share of banks planning to increase their real estate lending looking forward,” the ESAs said.
Banks’ exposure to residential and commercial real estate appears more vulnerable; as refinancing needs grow, particularly for high-yield debt and real estate, the ESAs expect credit risk to increase.
Cyber security risks are also increasing amid heightened geopolitical instability and increased reliance on digital solutions, the assessment warned. As the number of attacks and cyber threats increase, “it will be important to reflect on findings from cyber resilience testing currently underway,” the ESAs said.
