“The data for the first nine months of 2023 show a gradual but moderate increase in the volume of non-performing loans (NPLs). Inflationary pressures and market pressures on fragile portfolios characterized by credit risk, such as consumer credit and residential and commercial real estate, as well as in small and medium enterprises, continued. Therefore, increased provisions due to higher credit risk may adversely affect future earnings” according to the Annual Report of the ECB on its supervisory activity which was released today.

Although the NPL ratio remained flat overall in the 2023 cycle, the ECB noted a deterioration in portfolios that show greater vulnerability to inflationary pressures, including loans to households. It also noted a downturn in commercial real estate markets, as well as increased pressures on borrowers’ ability to refinance commercial real estate loans at maturity. In addition, business bankruptcies and default rates rose from low levels recorded during the pandemic.

Euro area businesses, especially SMEs, also continued to face difficulties due to higher financing costs, but also higher costs in general due to inflation. Heavily leveraged businesses or businesses in vulnerable sectors were hit hardest by rising costs and falling demand, which in turn put pressure on margins.

In her foreword to the Report, ECB President Christine Lagarde noted that banks maintained satisfactory capital adequacy and liquidity ratios, with the total Common Equity Tier 1 (CET 1) ratio of supervised banks standing at 15.6%, close to an all-time high of the level.

However, he warned that several challenges remain. While higher interest rates have weighed on net interest margins for eurozone banks, with the average ROE at 10% in Q3 2023, deposit rates are rising and so are non-performing loans.

For her part, the President of the Supervisory Board, Claudia Buch, argued that European banks have proven to be resistant to the disturbances that have hit our economies in recent years. The COVID-19 pandemic, rising energy prices and inflation, Russia’s invasion of Ukraine and, more recently, the conflict in the Middle East have put pressure on Eurozone economies.

“Higher interest rates have certainly been a major factor contributing to the sharp increase in bank profitability, and for the additional reason that banks have been slow to adjust deposit rates. Banks’ capital adequacy ratios remained satisfactory and well above supervisory requirements. At the same time, their liquidity ratios remained satisfactory, even after the gradual withdrawal of the favorable financing provided by the ECB.