Most of Europe's largest banks posted higher core capital ratios in the second quarter, strengthening their ability to mitigate the negative effects of the coronavirus pandemic, S&P Global Market Intelligence data shows.
Nevertheless, the recent resurgence of COVID-19 infections across the continent has cast a cloud over the prospects for an economic recovery and banks' credit losses, analysts said. "Currently, banks are very well capitalized but there is a great level of uncertainty about how asset quality will evolve in the future," John Cronin, financials analyst at Goodbody Stockbrokers, said in an interview. The longer the world waits for a COVID-19 vaccine, the higher the likelihood of business failures and more unemployment, increasing banks' credit losses, he said.
It all comes down to whether bank profitability and capital buffers are adequate and whether they can absorb the losses caused by COVID-19, Suvi Platerink, a credit analyst with ING, said in a written comment. Banks with the smallest capital buffers above the SREP minimum requirements — the ECB's Supervisory Review and Evaluation Process, which it uses to determine capital requirements — are most at risk if their profits collapse due to soaring loan loss provisions, she said.
Eighteen of the 21 banks in the S&P Global Market Intelligence sample booked a quarter-over-quarter increase in their common equity Tier 1 ratios, with Barclays PLC and UniCredit SpA showing growth rates of more than 100 basis points, the data shows. French banks Natixis and Société Générale SA posted lower CET1 ratios as they booked high market losses due to coronavirus-related volatility. Danske Bank A/S, which boasted the highest CET1 ratio in the sample, did not book a change from the first quarter.
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Ample buffers
There is currently no reason for concern about the capitalization of large European banks, Sam Theodore, managing director at Scope Insights, said in an interview. Most credit institutions have "relatively sufficient" excess capital on top of their regulatory required minimums, and bank supervisors "are doing everything they can" to stimulate the sector to continue lending, he said.
Supervisors have already called on banks to use their capital buffers during the crisis and are not likely to pressure the sector on capital anytime soon, according to Theodore. Banks are increasingly turning into "glorified utilities" meant to support businesses and economies, and if the COVID-19 crisis goes on for longer, regulators will have no other choice but to continue easing lending conditions for banks, he said.
In an Oct. 8 address, Bank of England Governor Andrew Bailey called on banks to dip into their capital buffers despite there being a "natural unease" to run down capital ratios.
Nine banks in S&P Global Market Intelligence's sample, including U.K.-based Barclays, NatWest Group PLC, Lloyds Banking Group PLC and HSBC Holdings PLC, along with Credit Suisse Group AG, Netherlands-based ABN AMRO Bank NV, Italy's UniCredit, Germany's Commerzbank AG and French group BNP Paribas SA, booked a quarter-over-quarter reduction in their minimum capital requirements as regulatory measures were relaxed.
Barclays, which originally anticipated its second-quarter CET1 ratio to be lower than in the first quarter, managed to post its highest ever ratio partly due to rule changes over the second quarter, bank executives said at its first-half earnings call July 29.
Uncertainty calls for caution
Despite robust capital levels, the banking sector could still come under pressure, according to market observers. The sector, especially when it comes to larger banks, can be seen as "safer than ever before" in terms of capital and liquidity, Nigel Every, a director at the risk and compliance arm of global consulting firm Protiviti, said in interview.
But banks are in a difficult position because they must find the balance between maintaining sound credit quality while serving consumers and businesses hit by the COVID-19 pandemic, Every said. This situation will become more acute when the government support and forbearance schemes end. "There is a risk of a cliff edge," he said.
The uncertainty about the full extent of bank credit losses is high, according to Cronin. Previous assumptions about a V-shaped economic recovery have proven to be erroneous and there is no way to predict precisely how economic activity, unemployment and housing prices will develop in the future, he said. While the global economy rebounded over the third quarter, the momentum has started to slow, S&P Global Ratings said in an Oct. 6 report, warning of an uneven, K-shaped recovery, with certain sectors not expected to bounce back in 2020 or 2021.
Furthermore, "a very high degree of uncertainty" that credit losses will amount to what banks have modeled for despite their "pretty sophisticated" assumptions, Cronin said. Second-quarter data compiled by S&P Global Market Intelligence, showed a mixed picture of loan loss provisions at the largest European banks. There is a serious question about the amount of overall credit losses they will face post-COVID-19 "and the losses will go directly to capital," Cronin said.
Risk-weighted assets
The deterioration of asset quality will directly hit a key CET1 ratio component — risk-weighted assets, or RWAs, Paul van der Westhuizen, senior credit analyst at Rabobank Research, said in an interview. As the systemwide loan moratoriums are lifted, banks will have to acknowledge loans that are at significant risk of default, categorized as stage 2 loans under the International Financial Reporting Standard, or IFRS 9, and the ones in default, or stage 3 loans, he said. The migration of loans from performing to Stage 2 and Stage 3 will increase RWAs.
Regulators have already said banks need to move past the moratorium stage "and take the pain, so to speak" in order to provide a clearer picture of the actual state of their books, Van der Westhuizen said.
"[Banks] should take a long, hard look at their loan books and work out which of their clients are really going to survive the crisis," ECB Supervisory Board Chair Andrea Enria told Handelsblatt in an Oct. 12 interview. They need to start this review now, "so that the wave of bad loans doesn't have a chance to get too big," Enria said. Despite having allowed banks to reduce their capital buffers earlier this year, the ECB has been urging them "to analyze in more detail what effects the extraordinary recession triggered by the pandemic is having on their asset values," Enria said.
Regulatory relief measures have limited RWA inflation to some extent, making it easier for some banks to absorb the substantial increases in their lending books in the first half of 2020, ING's Platerink said. However, lending development has been quite mixed across countries, driven by the different COVID-19 government support measures taken in each country, she said.