Euro area banks have emerged from the pandemic largely unscathed, mainly due to the unprecedented support from governments, central banks, regulators and supervisors.
Bank
capital in the form of Common Equity Tier 1 even
increased throughout the pandemic and stood at 15.5% in the fourth
quarter of 2021, with banks boasting ample liquidity and low and falling
levels of impaired assets (the liquidity coverage ratio was 173.4%
while the ratio of non-performing loans was 2.1%). Banks’ return on
equity in the same quarter stood at 6.7%, and while this is slightly
below the third-quarter figure, profits were still higher than before
the pandemic. Still, it would be premature to give the all-clear just
yet. We might not have seen the full story on asset quality, as stage 2
classifications remain above pre-pandemic levels, forbearance of
performing exposures has increased, and defaults of non-financial
corporates rose in the fourth quarter of 2021 and the first quarter of
2022.
But with Russia’s war of
aggression on Ukraine, European banks face a new test of their
resilience. Though direct exposures to Russia, Ukraine and Belarus are
limited and concentrated in only a handful of banks, we do not yet know
the impact of indirect effects. This
is reflected in the results for the first quarter of 2022, which most
listed significant institutions have already disclosed: whereas banks
directly exposed to the conflict areas saw declining profits, the rest
of the sample still posted results broadly in line with those at the end
of 2021. But even if all euro area banks’ Russian exposures were to be
written off, the consequences should, in all likelihood, be manageable
for the banking system.
However,
indirect effects could be more significant. The war has accelerated the
increase in energy and commodity prices that started in 2021; it is
contributing to uncertainty and prompting drastic changes within the
energy sector, while also exacerbating the supply chain bottlenecks that
arose during the pandemic. The resulting spike in inflation and
slowdown in economic growth might impact more heavily on banks’ asset
quality. While
we have been focusing on credit risk since the outbreak of the
pandemic, we are now concentrating particularly on the energy-intensive
sectors, which are more affected by the war − rather than on the service
sectors, which were most affected by the pandemic − as well as on
sectors such as residential real estate, which may be influenced by the
increase in interest rates that is now expected.
These
challenges are clear and present, and they warrant close attention and
monitoring. But they are not the only challenges that banks need to
urgently address.
For their long-term
resilience, banks now need to fully embed climate-related and
environmental risks within their business strategies. The transition
towards a low-carbon economy poses significant risks to banks via a set
of transmission channels, for example through exposures to firms with
high carbon emissions or through assets that might be impaired by
climate-induced damage. That is why it is crucial for banks to develop a
strategy to mitigate the long-term impacts of climate-related and
environmental risks and adjust their processes and internal practices.
The sharp rise in fossil energy prices may accelerate the green
transition. And as Europe tries to wean itself off Russian oil and gas
amid the war in Ukraine, this transition is no longer imperative from
only an ecological and economic perspective, but also from a security
standpoint. All these factors could precipitate transition risk for
banks.
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