The European Central Bank (ECB) has just raised a warning flag. It says the region’s banks are showing early signs of stress, with a notable rise in souring loans. Both companies and individuals are experiencing rising default rates and an increasing proportion of overdue loans, with the latter now exceeding the historically low levels observed in 2022.
Commercial real estate company loans and residential mortgages have been performing particularly poorly – a result of a recent downturn in European property markets. And that’s driving a big increase in non-performing loans (NPLs). (An NPL is a loan in which the borrower has not made the scheduled payments of principal or interest for a specified period, typically at least 90 days.) NPLs had been in a long period of decline, but in the second quarter of this year, they saw a net rise of about €2.5 billion ($2.74 billion) among commercial real estate loans and €1 billion ($1.1 billion) for consumer loans.
The good news is that the ECB says it’s confident the banking system can handle a worsening in its asset quality, thanks to its stronger capital and liquidity position. The eurozone banking system, after all, managed to remain resilient during the banking sector’s turbulence earlier this year, which saw the collapse or 11th-hour rescue of several US and Swiss banks, including Silicon Valley Bank and Credit Suisse. But the bad news is that an increase in loan defaults, coupled with a big drop in lending volumes and increased funding costs as banks pass on higher interest rates to depositors, will be major headwinds for banks’ profitability.
