European banks face major losses from bad loans and other costs caused by the COVID-19 pandemic, and their profitability is at record low levels, the European Banking Authority warned in a report published on Friday (11 December).
In its annual Risk Assessment of the European banking system, the regulator said that costs caused by the pandemic and general economic uncertainty are weighing on the profitability of European banks, already affected by low interests rates and Fintech competition.
In June, the average return on equity (RoE), an indicator to measure profitability, stood at 0.5%, down from 6.7% in June 2019, a record low level.
Some of the costs will disappear once the pandemic is over, and the regulator noted that the pandemic could be a catalyst for many clients to become digital customers, which could bring further savings.
Still, the banking authority recommended European banks explore potential mergers and acquisitions to exploit synergies and cut costs.
The report concluded that the bloc’s banks maintained solid capital and liquidity ratios and increased their lending to the real economy during the first wave of the pandemic.
The document noted that non-performing or ‘bad loans’ fell to 2.9% of the total at the end of the second quarter.
The impact of the virus was contained thanks to the extraordinary measures adopted by governments and regulators, such as delays on loan repayments and public guarantees, and the cash provided by central banks.
But once the COVID-19 related measures are phased out, it is “very likely” that the quality of the bank assets will deteriorate further, the EBA said.
In this regard, the regulator noted that although the level of non-performing loans continued to decline, other indicators already showed signs of deterioration in the banks’ books. For example, the volume of debtors that benefited from forbearance concessions “increased markedly”.
For that reason, the EBA recommends that banks prepare for the coming turbulence by engaging “as soon as possible” with struggling borrowers to find solutions.
Analysts agreed that private debt restructuring should take place as soon as possible, as more options are available compared with the previous financial crisis, such as improved insolvency proceedings framework.
This year, the EBA also launched an exercise on climate risk with a sample of 29 volunteer banks. It concluded that, in the long term, more than 50% of exposures to large corporates are to sectors potentially vulnerable to climate risk.
[Edited by Benjamin Fox]