The report also puts forward possible measures for addressing these risks through coordinated policy and supervisory actions.
Main findings
Throughout the first semester of 2013, the EU banking sector has continued to observe limited improvements in market confidence from both debt and equity investors. In 2011 and 2012, also thanks to the initiatives carried out by the EBA, capital levels improved despite the challenging conditions in financial markets. Nonetheless, the deterioration of the quality of banks' loan portfolios, as well as low profitability levels, may still pose challenges in maintaining adequate capital levels and therefore need to be monitored carefully.
More generally, there is increasing uncertainty about the quality of banks' assets and valuation. The agreement reached at the EBA table on the need to conduct asset quality reviews across major EU banks will contribute to dispel concerns over the deterioration of loan books, especially if appropriate and consistent disclosure is provided.
Profitability has continued to face significant headwinds that are not likely to dissipate in the second half of 2013. The low interest rates environment creates some pressure on bank net interest margins, particularly for banks with exposures to tracker-type mortgages, and increases the risk of hidden forbearance, which in turn leads to the build-up of latent credit risk and to inefficient market allocation of available credit resources. At the same time, net interest margins are under pressure due to higher private funding costs.
On the funding side, the funding conditions have made progress, with some consistent banks' issuance of unsecured debt. There has also been some evidence of deposit inflows from both retail and corporate customers. However, the persistent high reliance on public sources, subdued access to markets, increased reliance on collateral and bail-in uncertainties, remain matters of concern.
Significant strategic and implementation challenges are looming ahead also in view of the entrance into force of the new regulatory framework. Some uncertainties also remain including on bail-in requirements. In addition, the banking sector is facing a fragmentation of the single market, which hardens the sovereign-bank linkage, and affects cross-border interbank markets.
A number of detrimental business practices of EU banks have also affected consumer confidence and, therefore, increased reputational risks linked to the relationship between banks and consumers. More recent episodes of inappropriate conduct include mis-selling of products, failures with regard to rate benchmark setting and taxation issues. This will require heightened supervisory oversight and improvements in institutions' risk management functions, compliance procedures and risk culture.
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