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EU Banking Sector Risk Dashboard Summary (Q1 2019)

Core Content

This document presents a comprehensive overview of the risks and vulnerabilities faced by the EU banking sector as of Q1 2019, focusing on capitalisation, asset quality, profitability, funding and liquidity, and operational resilience. The data is derived from a sample of 186 European banks, with detailed statistics and analysis provided by the European Banking Authority (EBA).

Main Risks and Vulnerabilities

1. Asset Quality

• Non-Performing Loan (NPL) Ratio:
  • Declined to 3.1% from 3.2% in the previous quarter.
  • The decline was supported by a 3.4% increase in total loan volumes.
  • NPLs increased slightly from EUR 659bn to EUR 663bn.
• Short Term Outlook:
  • Political and economic uncertainty may slow down NPL reduction.
  • A deteriorating economic environment could lead to an increase in NPLs, especially for high-risk exposures such as leveraged loans and CRE financing.
  • Countries with higher economic volatility may see negative impacts on asset quality.
  • Lending standards may ease due to competition, which could affect asset quality if the economic climate worsens.

2. Market Risk

• Market Volatility:
  • Increased after a contraction at the beginning of Q1.
  • Higher volatility can be a source of earnings for some banking models but also leads to mark-to-market losses in certain countries.
• Short Term Outlook:
  • Market risk is closely tied to political and economic developments.
  • A materialisation of political event risk or a deteriorating economic outlook could lead to high volatility and sharp asset repricing.
  • A sudden dry-up in financial market liquidity may exacerbate these risks.
  • Emerging market exposures remain a concern, especially in the case of capital flight.

3. Liquidity and Funding

• Loan-to-Deposit Ratio:
  • Continued its downward trend to 116.8%, down from 117.0% in the previous quarter.
• Liquidity Coverage Ratio (LCR):
  • Continued its upward trend, reaching 152.7%.
• Asset Encumbrance Ratio:
  • Declined slightly to 27.6% from 28.0% in the previous quarter.
• Short Term Outlook:
  • Weakening investor demand could increase funding costs, particularly for bail-inable instruments.
  • Banks with weaker market perceptions may be more affected by potential price increases.
  • In case of significant constraints in market-based funding, banks may turn to the TLTRO3 programme.
  • The TLTRO3 is expected to increase the issuance of covered bonds, which offer attractive pricing.

4. Profitability

• Return on Equity (RoE):
  • Remained weak at 6.8%, slightly improving from 6.5% as of year end 2018.
  • Still below the cost of equity, indicating potential unsustainability of certain business models.
• Cost to Income Ratio (CIR):
  • Increased to 66.3%, the highest since December 2014, up from 64.6% in the previous quarter and 65.0% a year earlier.
  • The increase was driven by higher costs than the growth in net operating income.
• Net Interest Margin (NIM):
  • Tightened by 5 basis points (bp) to 1.42%, now at its lowest level.
• Short Term Outlook:
  • A slowdown in economic growth could further pressure bank revenues.
  • Competitive pressures from incumbents and FinTechs may increase.
  • Rising cost of risks and deteriorating asset quality could be expected.
  • Administrative expenses are expected to increase due to the need for further IT investments.

5. Operational Resilience

• Conduct Related Risks:
  • Increased with more fines and settlements, including those related to FX, tax, and sanction breaches.
  • AML breaches have emerged, and not all similar cases may have surfaced.
• Cyber Risk:
  • Remains a significant concern.
  • Banks and financial market infrastructure are vulnerable to cyber risks, system failures, or outages.
  • Recent cases of improper risk exposure calculations have revealed capital shortages and affected reputations.

Key Risk Indicators (RIs) Overview

1. Solvency Tier 1 Capital Ratio

• Weighted Average: 14.7% (unchanged from previous quarter).
• Trend: Both numerator (capital) and denominator (risk exposure amounts, REAs) increased, but the numerator increased more slowly.
• Country Dispersion: Varies across the EU, with some countries reporting below average levels.
• Size Class: Small banks have lower ratios than large banks.

2. CET1 Ratio

• Weighted Average: 14.7% (unchanged from previous quarter).
• Trend: Similar to Tier 1 capital ratio, but with more pronounced variations.
• Country Dispersion: Varies significantly, with some countries reporting below 11%.

3. Non-Performing Loans and Advances (NPL Ratio)

• Weighted Average: 3.1% (down from 3.2%).
• Trend: Continued decline, though at a slower pace.
• Country Dispersion: Some countries have higher NPL ratios, particularly those with subdued asset quality.

4. Coverage Ratio for Non-Performing Loans and Advances

• Weighted Average: 34.4% (down from 36.6%).
• Trend: Decreased, indicating lower coverage of NPLs.
• Country Dispersion: Varies, with some countries showing lower coverage ratios.

5. Forbearance Ratio for Loans and Advances

• Weighted Average: 29.4% (down from 29.2%).
• Trend: Decreased, suggesting reduced forbearance.
• Country Dispersion: Varies, with some countries showing higher forbearance ratios.

6. Return on Equity (RoE)

• Weighted Average: 6.8% (slightly improved from 6.5%).
• Trend: Remained weak and below cost of equity.
• Country Dispersion: Varies, with some countries reporting lower RoE.

7. Cost to Income Ratio (CIR)

• Weighted Average: 66.3% (up from 64.6%).
• Trend: Increased, driven by higher costs than net operating income.
• Country Dispersion: Varies, with some countries reporting higher CIR.

8. Loan-to-Deposit Ratio

• Weighted Average: 116.8% (down from 117.0%).
• Trend: Continued decline, indicating reduced lending relative to deposits.
• Country Dispersion: Varies, with some countries reporting higher ratios.

9. Leverage Ratio

• Weighted Average: 5.3% (as of Sep 2016).
• Trend: Varies, with some banks reporting below the minimum requirement.
• Country Dispersion: Varies, with some countries reporting lower leverage ratios.

Conclusion

The EU banking sector shows a generally strong capitalisation, but asset quality improvements have slowed, with NPLs increasing slightly due to one-off events. Profitability remains weak, with RoE below cost of equity, and CIR at a high level. Funding and liquidity have remained stable, but there are concerns about weakening investor demand. Operational resilience is a key area of focus, with increased conduct-related risks and ongoing cyber threats. The sector faces continuous challenges in maintaining profitability and managing risks in a changing economic and political environment.