Covid-19: EBA confirms banks’ solid capital and liquidity positions but warns about asset quality prospects

Covid-19: The European Banking Authority (EBA) has just published its annual Risk Assessment of the European banking system.

The report is accompanied by the publication of the 2020 EU-wide transparency exercise, which provides detailed information for 129 banks across 26 EEA / EU countries and for 6 banks from UK.

Despite the COVID-19 shock, banks have maintained solid capital and liquidity ratios and have increased their lending to the real economy.

However, economic uncertainty persists, profitability is at record low levels, and there are several early signs for a deterioration in asset quality.

Key figures

Banks have maintained strong capital and liquidity positions while they have increased lending to the real economy.

Capital and liquidity ratios well above regulatory minimum allowed banks to provide necessary financing to non-financial corporations at the beginning of the crisis.

Public guarantees and regulatory relief measures helped CET1 levels to recover from the initial hit after the outbreak of the pandemic, while extraordinary central bank facilities helped banks to maintain ample liquidity buffers despite tensions in wholesale funding markets.

However, the leverage ratio fell slightly as total assets grew more than capital.

Asset quality is expected to deteriorate materially over the next quarters

Banks have booked significant provisions on performing loans that have resulted in a material increase in cost of risk. Although NPL ratios have continued to decline, other asset quality metrics already show signs of deterioration. Loans classified under IFRS 9 stage 2 and forborne exposures have increased markedly. The phasing out of COVID-19-related measures, such as moratoria on loan repayments and public guarantees, will also likely affect asset quality. In the long term, it is noteworthy that, according to an EBA preliminary analysis, more than 50% of exposures to large corporates are to sectors potentially vulnerable to climate risk.

Banks’ operational resilience has been broadly unaffected despite the challenges posed by COVID-19. Nonetheless, the usage of information and communication technology (ICT) has grown further, increasing technology-related risks. Money laundering cases still pose important legal and reputational risks.

Banks’ structural profitability challenges remain

Low interest rates, which may stay lower for longer than expected prior to the pandemic, and strong competition from both banks and non-banks, like FinTech firms, are adding pressure to banks’ core revenues.

The recent fall in operating expenses has offset somewhat the pressure on pre-provision profits, yet these costs might bounce back once the pandemic is over.

COVID-19 might at the same time be the catalyst for many clients to become digital customers, hence increasing branch overcapacity. Banks might opt for M&A deals to exploit potential cost synergies.