“We believe NPLs will continue rising in 2024 but a shock is unlikely since NPL formation has been contained and is spread widely across countries and sectors,” said Nicolas Hardy, deputy head of financial institutions. “At the same time, higher interest rates are boosting earnings for many European banks while credit loss-absorption capacities are stronger.”

Hardy makes several strong arguments pointing to resilient asset quality in 2024: the reversal of the asset-quality improvement trend is starting from a low point; there is no broad-based deterioration of asset quality at this point; the focus is on identified pockets of risk such as commercial real estate and corporate credit exposures that tend to be granular; economic recovery in the euro area is likely to be modest but we do not foresee recession; and higher interest rates boost earnings generation and loss-absorption capacity.

“Even if asset-quality concerns are exacerbated in the case of a prolonged period of tight monetary policy, we do not believe a repeat of the previous asset-quality cycle, with NPLs reaching 2015-like levels, is on the cards,” Hardy added.

NPL ratios

*Data as of June 2023. Source: banks, SNL, Scope Ratings

Business model de-risking, better origination standards, more proactive supervision of credit risk and a largely positive inflation outlook are key differentiating factors compared to a decade ago. Countries that contributed extensively to the accumulation of NPLs in the past (e.g. Italy or Greece) are due to perform well compared to peers.

Despite the rapid increase in interest rates over the last 18 months or so, the average EU NPL ratio reported by the EBA has moved only marginally, by a few basis points, remaining close to 1.8%. Credit risk in the commercial real estate sector remains under the spotlight: price corrections continue and tighter refinancing conditions are adding pressure but we view the recent insolvency of Signa as an outlier rather than a typical example of the challenges facing the sector. Banks’ exposures are manageable in comparison to their loss-absorption capacity.

Cost of risk was modest in the first nine months of the year – around 45bp at EU level – and in line with or below 2022 figures. Cost of risk for the full year is expected to be closer to the through-the-cycle or medium-term averages. “We do note that the proportion of provisions related to Stage 3 loans is trending higher, though, indicating an increasing materialisation of credit risk,” Hardy said. “But precautionary provisions accumulated during the pandemic period are still largely in place and can be used to proactively manage NPLs as they emerge.”

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