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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...
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