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2022 was in many ways a turbulent year. As the EU economy and its banking sector were moving along a path of steady recovery from the pandemic, the Russian invasion of Ukraine, at the beginning of the year, proved to be the root cause of yet another important exogenous shock. However, banks remained resilient and managed to smoothly navigate the changing geopolitical and macroeconomic environment. While the fast-paced adjustment of interest rates allowed the banking sector to reach record levels of profitability and improve its market valuations, it also gave rise to the need to proactively manage interest rate risk, funding and liquidity risk. The strength of banks’ balance sheets has been a crucial factor for weathering the turbulence which has materialised on banking and financial markets over the past few weeks. I would now like to elaborate on the supervisory developments over the past year, given that the more recent turbulent events will be discussed in a separate session later on this afternoon.
Banks’ capital and liquidity positions remained solid and well above minimum requirements, with the aggregated Common Equity Tier 1 ratio standing at 15.3% and the liquidity coverage ratio at 161% at the end of the fourth quarter of 2022.[1] In addition, the volume of non-performing loans continued to decline, with the non-performing loans ratio standing at 1.8% in the fourth quarter. Return on equity reached its highest level since the start of the banking union, to stand at 7.7% in the fourth quarter of 2022.
Supervisory work first and foremost focused on monitoring the activities and the risk reduction efforts made by banks with direct exposures to Russia and, in particular, those established in the Russian market. This work is still ongoing, for while total euro area banks’ direct exposures to Russia had declined by around 20% as at the third quarter of 2022, the exit strategy used by some banking groups still present in Russia has not thus far delivered the results expected.
Against the backdrop of energy price inflation and heightened volatility of commodity prices, we used available granular credit risk data to monitor banks’ credit exposures to energy-intensive sectors, such as metal and chemical products, commodity goods and energy utilities. In the light of the lessons drawn from the collapse of Archegos in 2021, we also turned our attention to possible risks arising from financial market dislocations, which could primarily affect non-bank financial counterparties. By reviewing the governance and risk management practices of those significant institutions most exposed to counterparty credit risk and risks related to prime brokerage, supervisors were able to identify and tackle those deficiencies which, if left unaddressed, would overly expose banks dealing in derivatives and offering clearing, securities and investment banking services to other banks and non-bank financial institutions.
Finally, we focused on the risks arising from the upward shift in interest rates. In particular, we carried out a targeted review of interest rate risk and credit spread risk in the banking book and we looked closely at exposures to sectors especially sensitive to interest rates, such as commercial and residential real estate lending and leveraged finance. Leveraged finance also became the object of a dedicated Pillar 2 capital requirement add-on as a result of the Supervisory Review and Evaluation Process (SREP) decision, which was targeted at a handful of highly exposed banks....
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