Problem loans at European banks fell nearly 3% in the last three months of 2022, as asset quality improved in key segments such as commercial real estate and small businesses.
European banks had €357.4 billion of nonperforming loans (NPLs) at the end of 2022, down from €367.4 billion in the previous quarter and €391.4 billion a year earlier, according to the European Banking Authority's latest risk dashboard. The NPL ratio, which measures NPLs against total gross loans, was largely unchanged quarter on quarter due to a parallel decline in lending.
The NPL ratio for lending to commercial real estate dropped to 3.7% at the end of the year, from 4.1% three months earlier, while for small and medium-sized enterprises, the ratio fell to 4.3% from 4.4% over the same period. Bank exposures to commercial real estate have drawn particular investor focus after the troubles of SVB Financial Group spurred concerns over the sensitivity of highly leveraged sectors to rising interest rates.
Despite the positive trends, the regulator warned that higher interest rates, persistency in inflation and macroeconomic uncertainty could hurt asset quality as bankruptcies rise.
Improvements across sectors
European banks recorded improvements in asset quality across sectors such as accommodation and food services, construction and real estate.
The NPL ratio for accommodation and food services, the highest of all sectors, dropped to 7.9% at the end of 2022 from 8.4% in the previous quarter, with improvements recorded in major economies such as Italy and Spain. For construction, the ratio fell to 6.2% from 6.7% over the three-month period, with declines recorded in economies such as France, Germany and Italy.
For real estate activities, which represented 25.0% of European bank loans and advances to nonfinancial corporates at the end of 2022, the NPL ratio fell to 1.8% from 2.0% in the third quarter.
Asset quality deteriorated in some sectors, with the NPL ratio for health services and social work rising to 4.9% at the end of 2022, from 2.2% three months earlier. The sector represents 1.8% of European bank loans and advances to nonfinancial corporates. The NPL ratio for agriculture, mining, and finance and insurance activities also increased slightly. In Germany, the mining and quarrying NPL ratio rose to 13.1%, from 8.1% in the previous quarter.
Stage 2 loans down
Other asset quality indicators improved across the European banking sector. The stage 2 ratio, representing the proportion of loans that have had a significant increase in credit risk but no objective evidence of impairment, decreased to 9.41% at the end of 2022, from 9.56% in the previous quarter.
However, the European Banking Authority (EBA) warned of future risks to asset quality, noting that declared bankruptcies in Europe reached a new high at the end of 2022 and that the trend of rising bankruptcies had recently become more broadly based among countries.
"Higher interest rates, persistency in inflation and macroeconomic uncertainty could weigh on economic growth and unemployment rates, which in turn could adversely affect banks' asset quality," the EBA said.
Heightened macroeconomic uncertainty prompted European banks to increase provisioning levels in the last quarter of 2022. This drove cost of risk up to 0.46% from 0.43% quarter over quarter, though it was still lower compared to a year earlier and pre-pandemic levels.