S&P Global Ratings considers that the impact of the COVID-19 pandemic combined with the oil price collapse will weigh on the profitability and asset quality of many financial institutions operating in Europe, the Middle East, and Africa (EMEA).

Extended lockdowns, a slower pace of normalization, and key trading partners embroiled in the same predicament have all contributed to a very sharp downward revision to European economic growth for 2020. We now expect a deeper two-quarter recession in the eurozone, with full-year growth falling by 7.3% this year, before rebounding by 5.6% in 2021.

The uncertainties attached to the strength and shape of the recovery in 2021 remain significant. In large part, this reflects the pandemic's severity and the risks involved in normalizing social interactions until antibody testing and a vaccine become widely available. But it also reflects growing concerns about how long it could take for barriers to trade to be removed (reopening external borders and restoring travel, for instance).

The authorities have rolled out emergency measures to bridge short-term liquidity problems, hoping to avoid a surge in insolvencies and unemployment. And the fiscal programs are substantial, delivered in the form of grants, loan guarantees, and deferred tax arrangements, as well as worker subsidy packages. A significant component of these fiscal support packages comprises additional indebtedness--for the sovereign, some households, and many businesses. And at best, the easing of social-distancing measures is likely to be slow, and could be subject to setbacks. The longer the delay in the recovery of economic activity, the less sustainable this extra debt will be.

As a result, we consider the following the top risks: the pandemic not being contained despite all efforts; a scarcity of financing for indebted corporate borrowers; the re-emergence of global trade tensions including between the EU and the U.K.; and asymmetric fiscal costs from the pandemic placing renewed pressure on the EU's cohesion.

While we expect banks across Europe to remain resilient to the economic shock--thanks to measures to combat the coronavirus--asset quality, revenue, and profitability are likely to take a substantial hit, and capitalization will likely weaken. These negative trends were partially evident in banks' first-quarter results, but are likely to become increasingly apparent in subsequent quarters, with weakness persisting into 2021.

Banks in emerging markets are also exposed to additional risks, including high reliance on external funding, concentrated economies, governments' lack of capacity to provide support, and higher risks of social tensions.

Our central scenario is that we will not lower the ratings on the majority of banks across jurisdictions as a result of the COVID-19 pandemic. This is because government support packages will cushion the impact on households and corporate borrowers and, in turn, banks. That said, the risks to our baseline macroeconomic forecast remain firmly on the downside, since the translation from health outcomes to economic variables are highly uncertain. The contours of the recovery, in particular, are still hard to predict. We have therefore increased the number of entities and geographies within EMEA for which we signal material downside risk to our base case.

The net rating bias for financial institutions in EMEA has turned markedly negative this quarter, following the recent downward revision of our central economic forecasts, continued material downside risks to these forecasts, and the potential longer-term impact on banks' profitability. The majority of bank downgrades to date have occurred in jurisdictions in which the oil price decline also contributed materially to our expectation of weakened operating conditions for banks. In countries little affected by events in the oil market, our bank rating actions have mainly consisted of downward outlook revisions.

S&P Global Ratings acknowledges a high degree of uncertainty about the rate of spread and peak of the coronavirus outbreak. Some government authorities estimate the pandemic will peak about midyear, and we are using this assumption in assessing the economic and credit implications. We believe the measures adopted to contain COVID-19 have pushed the global economy into recession (see our macroeconomic and credit updates here: www.spglobal.com/ratings). As the situation evolves, we will update our assumptions and estimates accordingly.

We continue to expect that bank rating downgrades this year resulting from the COVID-19 pandemic will be limited.  Although the outlook on banks has turned sharply more negative in the past few weeks, reflecting the significant effects of the pandemic, oil price decline, and market volatility, most ratings have been affirmed. This is because we still anticipate that banks will remain largely resilient, for the following key reasons:

• The generally strong capital and liquidity position of banks globally at the onset of the pandemic, supported by a material strengthening in bank regulations over the past 10 years;
• The substantial support and flexibility that banking systems will receive from public authorities to entice them to continue lending to households and corporates, whether in the form of liquidity or credit guarantees, and relief on minimum regulatory capital and liquidity requirements;
• The unprecedented direct support that governments will provide to their corporate and household sectors;
• The likelihood, in our base-case scenario, of a 5.9% rebound in global GDP in 2021 after a sharp contraction by 2.4% this year, even if this contraction and ensuing recovery varies considerably between countries; and
• Technology being an ally of banks in this crisis. Despite geographic variations, banks have for years been investing in their digital transformation and adopting new technologies to meet customers' evolving expectations and to control costs. In a context of social-distancing requirements, this has enabled most banks to transition a large part of their operations away from office and branch environments, while continuing to transact with customers.

At the same time, we expect an increasing number of negative outlooks on European banks in 2020.   We foresee lower revenues and hikes in credit provisions, the latter in spite of significant government support packages. The negative impact will likely be more pronounced for those banks that have larger exposure to the sectors most affected by the COVID-19 pandemic such as hotels and tourism, small to midsize enterprises (SMEs) and unsecured consumer lending. However, we consider that mortgage portfolios will likely remain resilient to the current stress, thanks to various government support measures. Banks' performance is likely to improve in 2021, but is unlikely to reach pre-pandemic levels quickly in most markets. Capital deterioration, however, should be modest (although uneven), particularly if banks do not distribute dividends as recommended by authorities, and funding should not be an issue for banks given ample availability of central bank funding. Ratings pressure is more likely to affect banks with existing fragilities (such as weak earnings, incomplete restructurings or turnarounds, business model challenges, or tighter capital); banks with material exposure to regions most affected by the lockdown, or with limited fiscal space to undertake borrowers' support measures; and those banks and nonbank financial institutions reliant on market funding access.

The next few quarters are likely to show up differences between banks in the way they book provisions against future credit losses.  Banks' first-quarter results highlighted that some took more conservative approaches than others in estimating expected credit losses on their loan portfolios. History shows that banks with relatively stronger capital and earnings profiles are usually faster in recognizing asset-quality deterioration through earlier provisioning. While that weighs on earnings and capital initially, it should mean their provisions will be lower in future periods than they would otherwise have been. Still, we expect sustained high loan-impairment charges in second-quarter results in most banking sectors. Whether this amounts to a further surge, or rather a top-up, will likely vary from bank to bank, contingent on the prudence that management exercised in first-quarter results, the effectiveness of government fiscal support for borrowers, and banks' idiosyncratic factors.

EMEA's Additional Tier 1 (AT1) market is seeing changing rules of the game due to COVID-19.  About 10 years after their introduction to the market, European bank AT1 contingent capital securities face their first significant stress of a global recession, as both the COVID-19 pandemic and oil market volatility intensify. The regulatory response to the COVID-19 outbreak, including cutting buffer requirements and squeezing shareholder distributions, aims to encourage banks to extend credit to the real economy without fear of breaching regulatory requirements. Furthermore, we note statements such as that from the European Central Bank's (ECB's) Prudential Supervisory Board, which said it has no plans to compel banks to suspend payments on their may-pay hybrids. At this point, we expect European banks will continue to service their AT1 coupons, but we remain alert to the possibility that, in time, nonpayment risk could rise if bank capitalization weakens very significantly.

Similarly, for Gulf Cooperation Council (GCC) banks, we see the COVID-19 pandemic and the drop in oil price as a profitability rather than a capital event, and therefore we expect banks to continue paying coupon payments on their hybrid instruments.

Many European banks are adjusting planned dividends and buybacks following regulatory requests for prudence during the COVID-19 pandemic.  We view European regulators' request to banks to consider adjusting dividends and suspending share buybacks as an understandable precautionary measure, given uncertainty over the length and depth of the ongoing stress. Many European banks subsequently announced full or partial dividend cancellation or deferrals and temporary suspension of share buyback programs While these deferrals aid banks' flexibility to absorb outsized losses through 2020 and continue backing credit growth, in general they did not affect our risk-adjusted capital (RAC) ratios for these banks, because the payments have typically been postponed rather than cancelled.

Turbulent capital markets will mean additional pressure for many emerging markets' banking sectors, which we expect to face asset quality deterioration, and weakening profitability and capitalization.  In addition to asset quality worsening as a result of the COVID-19 pandemic and oil-price decline, many banks in emerging markets are exposed to additional sources of risks, including:

• Heavy reliance on external funding amid changing investor sentiment and the unprecedented pace of capital outflows;
• Concentration of their economies on specific sectors (such as the hospitality sector or industrial or service exports to developed countries) or commodities (first of all, oil and gas, reflecting the fact that many developing economies of EMEA are particularly dependent on the oil export revenues, but also those commodities whose price dynamics are very sensitive to global economic growth prospects); and
• Lack of government capacity to provide extraordinary support, weaker governance and efficiency of government institutions, and a higher likelihood of political and social tensions.

We consider that the Russian banking sector is better positioned to face the current stress than in previous crises.  The oil price decline will compound the effect of COVID-19 on Russian banks' asset quality and profitability. Across the Russian banking sector, we expect the system to demonstrate resilience in the face of this short-term cyclical event. We also believe that funding will remain largely resilient, supported by the banks' reliance mainly on domestic deposits, limited external funding needs, and potential central bank liquidity support (see "Key Assumptions On Russian Banking Sector Remain Broadly Unchanged After Downward Revision Of Economic Prospects," April 24, 2020). We consider that most large banks in Russia appear better prepared to cope with adverse economic conditions than they were before past recessions.

We think that the Russian economy could absorb the current shocks and will likely start recovering, returning to growth of 4.5% in 2021, in line with a recovery in oil prices and the global economy. However, the risks to our baseline forecast remain firmly on the downside, and the speed of the recovery will depend on the efficiency of policy measures.

We consider that higher risks could stem from the banks' exposures to SMEs, which are likely to be hit harder than larger enterprises under the current macroeconomic scenario. However, the exposure to the SME segment is relatively moderate, at about 8% of the total loan book. Russian banks' books are dominated by large corporates, which generally have more buffers to withstand the temporary shock, while smaller companies may have less flexibility. We expect that nonperforming loans (Stage III loans) may reach up to 15% in 2020, compared with about 8% reported by the largest banks in 2019.

GCC banks' strong earning capacity will help them navigate COVID-19's effects and the oil price dive.  We expect banks in the GCC countries will see significantly reduced revenue and credit growth in 2020. Nevertheless, we think that rated banks' profitability and provision cushions built over past years will help them navigate the rough waters. Most rated GCC banks have relatively strong profitability and a conservative approach to calculating and setting aside loan-loss provisions. Some banks, for example those in Kuwait, take a conservative approach as part of local regulatory requirements to set aside general provisions for all their lending portfolios.

Overall, we estimate that rated GCC banks could absorb up to a $36 billion shock before starting to deplete their capital base. This corresponds to about 2.7x our calculated normalized losses, which implies a substantial level of stress in our view (our estimation is based on a sample of 23 rated commercial banks in the GCC with exposures predominantly concentrated in GCC countries). At year-end 2019, these banks' total assets reached $1.5 trillion.

Given that the GCC banks we rate take a relatively conservative approach toward the quality of their investment portfolios, we think that some of them stand to benefit from capital gains due to the shift in market conditions. In addition, we consider that banks' efficiency is very strong. The average cost-to-income ratio for rated GCC banks reached 37% at year-end 2019. This low level is explained by the low cost of labor, the absence of taxes and social contributions (except for nationals of the GCC countries), and a stringent approach toward cost control through small branch networks and leveraging technology for customer service.

We expect higher credit losses for South African banks.  We estimate real GDP growth for South Africa will contract by 4.5% in 2020, largely due to the COVID-19 outbreak, before rebounding to 3.5% in 2021. Global market dislocations led to massive portfolio outflows in first-quarter 2020 and caused the South African rand to weaken. We anticipate the banking sector will contract as a result of the economic recession in 2020. We also expect sector credit losses will rise to about 1.2% in 2020, mostly affecting retail and SME loans. Domestic households pose a significant source of risk for banks, because of their relatively high leverage and low wealth levels compared with other emerging markets. Household debt metrics, including affordability, will come under pressure in 2020. This is despite lower interest rates due to external shocks and the economic situation. In addition, we expect stress in the commercial real estate sector on the back of a prolonged economic lockdown and the gradual reopening of the economy.

Turkish banks are subject to several sources of stress.  Turkish banks remain highly vulnerable to negative market sentiment and risk aversion. Due to limited lending growth and a decreased debt rollover rate, net banking sector external debt gradually declined to 21.7% of systemwide domestic loans as of Dec. 31, 2019, and will continue declining over the next 12-18 months. However, we think Turkish banks' ongoing refinancing needs and access to external wholesale funding sources continue to threaten their financial positions.

Similar to other markets, Turkey's central bank and the bank regulator have introduced many forbearance measures, such as changes in loan classification rules, extending the overdue period for the recognition of lending as stage 2 and stage 3 loans, and neutralizing the impact of the lira's depreciation on the calculation of capital. We understand that these measures are temporary, and are designed to alleviate the impact of exceptional circumstances on the banking sector. Nevertheless, we consider that they could represent a possible step toward the weakening of supervisors' independence and their ability to oversee the banking sector effectively. In addition, banks have been asked to extend additional loans to corporate entities and SMEs. This means public-sector banks' loans books are rapidly expanding, distorting the competitive dynamics of Turkey's banking sector.

We now estimate in our base-case scenario that the Turkish economy will contract by 3.1% in real terms in 2020, before recovering by 4.2% in 2021. We expect the systemwide nonperforming loan (NPL) ratio to reach 10%-11% by the end of 2021, up from 5.8% at year-end 2019, and problematic loans (NPLs plus restructured loans) to exceed 20% of total loans, compared with about 10.1% as of Sept. 30, 2019. We expect banks' cost of risk to rise to between 320 bps and 330 bps on average in 2020 and 2021.

Key Banking Sector Risks In EMEA

The table below presents S&P Global Ratings' views about the key risks and risk trends for banking sectors in EMEA countries where we rate banks. For more detailed information, please refer to the latest Banking Industry Country Risk Assessment (BICRA) on a given country. According to our methodology, BICRAs fall into groups from '1' to '10', ranging from what we view as the lowest-risk banking systems (group '1') to the highest-risk (group '10').

Table 1

Selected Research

We have recently published a number of articles highlighting our views on EMEA banking sectors:

• LatAm Financial Institutions Monitor 2Q2020: COVID-19 Hits Banks' Bottom Lines, May 14, 2020
• Asia-Pacific Financial Institutions Monitor 2Q2020: COVID-19 Crisis Could Add US$440 Billion To Credit Costs, May 14, 2020
• How COVID-19 Is Affecting Bank Ratings: May 2020 Update, May 7, 2020
• Bulletin: Greece's And Cyprus' Banking Industry Risk Trends Shift Due To COVID-19 Shocks, May 7, 2020
• Will COVID-19 Trigger The Long Awaited Consolidation Of The Tunisian Banking System?, May 6, 2020
• Ratings On Three Tunisian Banks Lowered On Expected Weakening Financial Profiles, May 6, 2020
• Bulletin: Saudi Arabia Banking Industry Country Risk Assessment Trends Remain Stable Despite Oil Price Drop; No Ratings Affected, May 6, 2020
• COVID-19 Effects Might Quadruple U.K. Bank Credit Losses In 2020, May 4, 2020
• Banking Industry Country Risk Assessment Update: April 2020, May 1, 2020
• How COVID-19 Risks Prompted European Bank Rating Actions, April 29, 2020
• Outlook Revisions On Several Austrian Banks On Deepening COVID-19 Downside Risks, April 29, 2020
• Bulletin: Deepening COVID-19 Risks Cause Economic Risk Trends To Shift In Several CEE Countries, April 29, 2020
• Outlooks On Most Italian Banks Now Negative On Deepening COVID-19 Downside Risks, April 29, 2020
• Outlooks Revised To Negative On Several Spanish Banks On Deepening COVID-19 Downside Risks, April 29, 2020
• Various Rating Actions Taken On Azeri Banks On Expected Deepening Of Economic Turmoil On COVID-19 And Oil Price Decline, April 28, 2020
• Outlooks Revised On Three Irish Banks On Deepening COVID-19 Downside Risks, April 28, 2020
• Three Icelandic Banks Downgraded On Weaker Business Prospects And Effect Of COVID-19; Outlooks Stable, April 24, 2020
• Key Assumptions On Russian Banking Sector Remain Broadly Unchanged After Downward Revision Of Economic Prospects, April 24, 2020
• Negative Rating Actions Taken On Various French Banks On Deepening COVID-19 Downside Risks, April 23, 2020
• Negative Rating Actions Taken On Multiple Benelux Banks On Deepening COVID-19 Downside Risks, April 23, 2020
• Negative Rating Actions Taken On Multiple German Banks On Deepening COVID-19 Downside Risks, April 23, 2020
• Europe’s AT1 Market Faces The COVID-19 Test: Bend, Not Break, April 22, 2020
• How COVID-19 Is Affecting Bank Ratings, April 22, 2020
• How Resistant Are Gulf Banks To The COVID-19 Pandemic And Oil Price Shock?, April 22, 2020
• Credit FAQ: Will COVID-19 And Cheap Oil Reset The Market For GCC Tier 1 Instruments?, April 22, 2020
• So Far, So Good For Clearinghouses Despite Oil And COVID-19 Market Volatility, April 16, 2020
• Virus, Oil, And Volatility Will Put Sukuk Issuance Into Reverse, April 13, 2020
• Outlooks On Two Georgian Banks Revised As Economy Heads Toward Recession; Ratings On Three Affirmed, April 10, 2020
• Bulletin: Credit Suisse And UBS Accept Regulator’s Request To Partly Defer Dividends Despite Strong First-Quarter Performances, April 9, 2020
• COVID-19 Exposes Funding And Liquidity Gaps At Banks In The Middle East, Turkey, and Africa, April 6, 2020
• Industry Report Card: GCC Banks Face An Earnings Shock From The Oil Price Drop And COVID-19 Pandemic, April 6, 2020
• Three Big Risks For Kazakh Banks: Oil Prices, Foreign Exchange Rates, And The Coronavirus, April 2, 2020
• Recession And Market Volatility Will Test The Resilience Of Russian Banks, April 2, 2020
• European Banks' First-Quarter Results: Many COVID-19 Questions, Few Conclusive Answers, April 1, 2020
• Our Definition Of Default In The Context Of The EBA Guidelines, April 1, 2020
• Outlooks On Four Greek Banks Revised To Stable From Positive On COVID-19's Impact On NPE Cleanup Efforts, March 27, 2020
• Outlooks On Five UAE Banks Revised To Negative On Deteriorating Operating Environment, March 26, 2020
• Banking Industry Country Risk Assessment Update: March 2020, March 20, 2020
• COVID-19 Exacerbates Africa's Social And Macroeconomic Vulnerabilities, March 18, 2020
• COVID-19 Countermeasures May Contain Damage To Europe's Financial Institutions For Now, March 13, 2020
• The Coronavirus Pandemic Is Set To Test The Resiliency Of Italy's Banks, March 13, 2020
• Prolonged COVID-19 Disruption Could Expose The GCC's Weaker Borrowers, March 11, 2020
• Swedish Klarna's Deeper Teamwork With Chinese Tech Giant Could Further Challenge The European E-Commerce Payments Market, March 6, 2020
• Spanish Banks: At A Crossroads, March 6, 2020
• What's Next For Resolution Counterparty Ratings?, March 2, 2020
• Various Rating Actions On Swedish Midsize Banks As Resolution Regime Gains Effectiveness, Feb. 28, 2020

The Future Of Banking

Technological disruption leads to new customer expectations and new forms of competition, but also offers new opportunities for banks. All these trends may ultimately influence the credit profiles of banking industries across the globe. We have published a number of articles highlighting our views on the readiness of various banking sectors to face the challenges and opportunities arising from the development of financial technology and digital transformation:

• The Future Of Banking: Research By S&P Global Ratings, Feb. 19, 2020
• Tech Disruption In Retail Banking: Swiss Banks Are In No Rush To Become Digital Frontrunners, Feb. 13, 2020
• The Future Of Banking: When Central Banks Go Crypto, Feb. 11, 2020
• Tech Disruption In Retail Banking: The Regulator Is Moving Israeli Banks Into A Digital Future, Feb. 5, 2020
• Tech Disruption In Retail Banking: Nordic Techies Make Mobile Banking Easy, Feb. 4, 2020
• Tech Disruption In Retail Banking: Austrian Banks' Bricks And Clicks Model Still Does The Trick, Jan. 29, 2020
• Tech Disruption In Retail Banking: GCC Banks Are Catching Up As Clients Become More Demanding, Sept. 8, 2019
• The Future Of Banking: Fintech's Prospects In The Middle East And Africa, June 10, 2019
• Tech Disruption In Retail Banking: France's Universal Banking Model Presents A Risk, May 14, 2019
• Tech Disruption In Retail Banking: Swedish Consumers Dig Digital--And Banks Deliver, May 14, 2019
• The Future Of Banking: Will Retail Banks Trip Over Tech Disruption?, May 14, 2019

Economic, Sovereign, And Other Research

• COVID-19 Weekly Digest, May 6, 2020
• European Economic Snapshots: Larger Risks To Growth Loom Ahead, May 5, 2020
• COVID-19 Weekly Digest: Financial Markets Loosen Up Amid Stimulus, Shift Toward Easing Lockdowns, April 29, 2020
• Credit Conditions Europe: The Lowdown On Lockdowns, April 27, 2020
• Credit Conditions Emerging Markets: Longer Lockdowns, Heightened Risks, April 23, 2020
• Economic Research: EU Response To COVID-19 Can Chart A Path To Sustainable Growth, April 22, 2020
• Economic Research: Europe Braces For A Deeper Recession In 2020, April 20, 2020
• Economic Research: COVID-19 Deals A Larger, Longer Hit To Global GDP, April 16, 2020
• Credit FAQ: Sovereign Ratings And The Effects Of The COVID-19 Pandemic, April 16, 2020
• Global Credit Conditions: Triple Trouble: Virus, Oil, Volatility, April 1, 2020
• Economic Research: COVID-19: The Steepening Cost To The Eurozone And U.K. Economies, March 26, 2020
• Credit FAQ: Assessing The Coronavirus-Related Damage To The Global Economy And Credit Quality, March 24, 2020
• The European Central Bank Rises To The Challenge As Eurozone Sovereign Borrowing Soars In Response To COVID-19, March 19, 2020
• Economic Research: COVID-19 Macroeconomic Update: The Global Recession Is Here And Now, March 17, 2020
• Stress Scenario: The Sovereigns Most Vulnerable To A COVID-19-Related Slowdown In Tourism, March 17, 2020
• COVID-19 Credit Update: The Sudden Economic Stop Will Bring Intense Credit Pressure, March 17, 2020
• Sovereign Debt 2020: Emerging Market EMEA Borrowing Will Likely Inch Up 0.6% To $473.3 Billion, Feb. 20, 2020

BICRA Changes

Over the past quarter, we made the following changes to our Banking Industry Country Risk Assessments (BICRAs):

Austria

We have revised our economic risk trend for Austria to negative from stable. Until the start of March, Austrian banks were fully engaged with the same two key themes that have been paramount in recent years--harmonizing balance-sheet strength with solid investor returns, and identifying how to refine business and operating models in the face of the looming risks and opportunities of the digital era.

For the short term at least, the COVID-19 pandemic has changed (almost) everything. In addition to the human cost, large parts of economic activity in Austria and much of the rest of Europe have ground to a halt. With isolation strategies still very much in force, our economists expect sharp economic contraction in the second quarter of 2020, followed by a rebound starting in the third quarter. However, they are now more cautious on the strength of recovery through end-2020 and into 2021, envisaging a 7.3% GDP contraction in the eurozone, with a recovery of about 4.3% in 2021. Even under this base case, the effects of COVID-19 will be evident for long after the crisis subsides. Authorities have delivered unprecedented policy responses in the form of monetary, fiscal, and regulatory support to their economies. The better-capitalized, better-funded, more-liquid banks that have gradually emerged in Austria since the 2008-2009 global financial crisis have played an instrumental role as a conduit of the expansion of low-cost credit to affected households and businesses. However, while we expect banks in Austria and across Europe to remain resilient in the face of this short-term cyclical shock, we expect there will be a meaningful impact on asset quality, revenues, profitability, liquidity, and, potentially, capitalization.

We expect very few of these negative trends to be strongly evident in Austrian banks' first-quarter results, but consider that they would become increasingly evident through the course of 2020 and persist into 2021. Bank asset quality will be key to this outcome.

Belgium

We have revised our economic risk trend for Belgium to negative from stable. We believe the COVID-19 pandemic is lowering the earning prospects for all banks in the region. This stems from corporates' and SMEs' impaired ability to repay debt, as well as constrained household incomes. Despite their differences, the economies of Benelux (the economic union comprising Belgium, the Netherlands, and Luxembourg) are similar in that they are very open, and therefore largely dependent on the situation of their main European partners. Exports of goods and services represent more than 80% of GDP in Belgium.

We expect the COVID-19 pandemic to cause a severe recession in Belgium in 2020. While we expect a recovery in 2021, it will not immediately and entirely offset the damages caused to the economy, household wealth, and various corporate sectors.

France

We have revised both our economic risk trend and our industry risk trend for France to negative from stable. We see increased downside risks to French banks' credit profiles resulting from the economic and financial-markets implications of the COVID-19 pandemic. We expect the pandemic to cause a severe recession in France and most European countries in 2020. We anticipate a recovery in 2021, but not one that will immediately and entirely offset damage to the economy, household wealth, and various corporate sectors. We also note that this crisis comes at a time

when the French banking sector was already suffering profitability pressures from low interest rates and heavy cost bases.

Georgia

We have revised our economic risk trend for Georgia to stable from positive. This reflects the implications of the upcoming recession. However, under our base-case scenario, the economy will be recovering in 2021-2022. The country's economy has absorbed a number of shocks and demonstrated its ability to adjust to external challenges in previous crises.

Hungary

We have revised our economic risk trend for Hungary to stable from positive. This reflects that the medium-term improvement we originally expected is no longer realistic. At the same time, in our base-case scenario, we consider that our current economic risk assessment has sufficient room to be sustained as revenue deteriorates and the cost of risk rises across the banking system. Hungarian banks will inevitably suffer a rise in credit losses in 2020 and 2021, but we consider structural economic risks in the economy are lower than during the 2008-2009 financial crisis. Banks suffered from heavy credit losses in the commercial real estate segment, which was overheating shortly before the onset of that crisis, and the foreign currency risks embedded in Swiss franc housing loans are no longer issues today. Therefore, we expect credit risks to rise, but not to be exacerbated as they were during the 2008-2009 financial crisis.

Iceland

We have revised our BICRA for Iceland to group '5' from group '4', and our industry risk score to '6' from '5'. We anticipate a sharp reduction in economic activity for Iceland and Europe in 2020. In our view, this will exacerbate the structural weaknesses of the domestic banking industry.

We have also revised our economic risk trend for Iceland to negative from stable. The longer and deeper the economic contraction, the more it could impair Icelandic banks' asset quality, increase credit losses, reduce business and revenue generation, and potentially erode its capital. The banks' structural exposures to local SMEs--including tourism, which we view as a more vulnerable sector in the current context--and their exposure to the commercial real estate and construction sectors (about 20% of the total loan book) increase the risks. We generally consider that small-to-midsize banks with loan concentrations to SMEs in regions that are strongly affected by the COVID-19 pandemic are most susceptible, in the near term, to the deteriorating environment. Therefore, we now see a negative, rather than stable, trend for economic risk for the banks.

We have also taken a more conservative stance on the overall banking industry risks in Iceland. Icelandic banks were already facing a structural decline in their profitability levels and the current crisis will exacerbate this trend, in our view. The declining interest rates are putting net interest margins under mounting pressure. This, coupled with the stiff competition from pension fund mortgage lending in a low-diversified industry, made for bleak revenue trends. In addition, it will take time for the efforts to improve efficiency to materialize and counteract the inertial cost inflation in the banking industry. At the same time, credit provisions will increase materially as the effects of the COVID-19 pandemic build. We expect the cost of risk to reach about 100 basis points (bps) on average for the three commercial banks in 2020, from 30 bps in 2019, and the total amount of nonperforming assets (NPAs) on average loans to exceed 5% in the next two years (from about 3% in 2019). At the same time, we expect the lower-than-average NPA coverage ratio to remain around the current level, 40% on average. As a result, we expect banks to be close to breakeven in 2020, and profitability levels to remain structurally low through 2021.

Ireland

We have revised our industry risk trend for Ireland to negative from stable. This reflects the heightened downside risk we see for Irish banks to generate structurally sound profitability, which is more acute than fundamental and prolonged economic weakness in the economy. Indeed, profitability is under increasing pressure, due to a persistently high cost base as Irish banks continue investing into business transformation and digital capabilities, amid compressing interest margins and a lack of business diversity. Growth opportunities are modest and competition stiff given high industry concentration and the relatively small size of the domestic economy and bankable population. The rating actions we have taken reflect that we now see Irish banks' profitability remaining structurally low for at least the next two years, with return on equity in the low single digits.

Italy

We have revised our economic risk trend for Italy to negative from stable. We see increased downside risks to various Italian financial institutions' credit profiles due to the economic and financial market implications of the COVID-19 pandemic. We expect this pandemic to cause a severe recession in Italy, and indeed in most European countries, in 2020. Although we expect a recovery in 2021, we anticipate it will not immediately and entirely offset the damage caused to the economy, household wealth, and various corporate sectors.

We have also revised our industry risk trend for Italy to stable from negative. In our opinion, the relatively high cost base, compared with the amount of revenue banks are able to generate, constrains their ability to cushion rising business and credit losses. We think this could create more economic incentives for structural changes in the banking sector, including further consolidation over time. We also note that European authorities recently launched supportive measures, including the ECB's enlarged bond-buying program and funding availability for eurozone banks, which will mitigate any potential risks arising from Italian banks' exposure to market turbulence. In this context, we also note that the large and expanding retail funding base significantly reduces Italian banks' refinancing needs and provides them with a stable financing source.

Lebanon

We have discontinued our BICRA of Lebanon, since we no longer maintain public ratings on any bank based in the country.

Netherlands

We have revised our economic risk trend for the Netherlands to negative from stable. We believe the COVID-19 pandemic is lowering the earning prospects for all banks in the region. This stems from corporates' and SMEs' impaired ability to repay debt, as well as constrained household incomes. Benelux economies, despite their differences, are similar in that they are very open, and therefore largely dependent on the situation of their main European partners. Exports of goods and services represent more than 80% of GDP in the Netherlands.

We expect the COVID-19 pandemic to cause a severe recession in the Netherlands in 2020. Whie we anticipate a recovery in 2021, it will not immediately and entirely offset the damages caused to the economy, household wealth, and various corporate sectors.

Oman

We have revised our BICRA on Oman to group '7' from group '6'. We now see stable trend for industry risk and continue to see a negative trend for economic risk.

The change in our views on systemic risks in Oman follows the sharp drop in oil prices and reduced economic activity due to the COVID-19 pandemic. We believe these factors will significantly hamper Oman's economy. We expect asset quality indicators of the Omani banking system will deteriorate and the cost of risk will increase, weighing on banks' profitability in the next 12-24 months. The average ratio of stage 3 loans to total loans for the top nine banks (representing more than 95% of the system's assets) reached 3.7% at year-end 2019 compared with 3.2% at year-end 2018. Moreover, the coverage ratio of these loans by provisions (including for stage 1 and stage 2) stood at 88% at year-end 2019 compared with 104% at year-end 2018. High leverage in the retail segment combined with continued pressure on residential real estate and other sectors, like trade and hospitality, will push up the level of stage 3 loans. We expect these to increase to about 5% of total system loans in 2020-2021. The high amount of stage 2 loans in some banks' portfolios--20% of gross loans on average--will also contribute to the increase of stage 3 loans. We expect the cost of risk to rise to 100 bps-110 bps in the next two years, compared with an average of 45 bps between 2015 and 2019.

We believe the Omani government's capacity to provide guarantees and liquidity in a timely manner, should the need arise, has reduced. To counter the impact of COVID-19, the central bank of Oman implemented certain measures such as lowering capital conservation buffers and increasing the lending/financing ratio. We believe these measures will help maintain the liquidity of the banking system. However, high fiscal and current account deficits have eroded the government's traditional net asset positions, in turn weakening its ability to extend ongoing and extraordinary support to Omani banks. As a result, we now assess the capacity and willingness of Oman to support failing domestic banks during a crisis as uncertain.

Poland

We have revised our economic risk trend for Poland to negative from stable. The COVID-19 economic shutdown in Poland is likely to cause a recession that will abruptly halt the recent strong pace of real GDP growth in 2020. We expect a GDP contraction of 4% in 2020, followed by a U-shaped recovery with a rebound in GDP of 5% in 2021 so that GDP per capita will revert to $15,000 by 2022. In our view, the comparably lower wealth level in Polish society, which includes below-average saving rates and a moderate social security system compared with many of its peers, means that the private sector's debt capacity is under pressure. We expect a significant increase in the unemployment rate, coupled with an elevated level of consumer loans in the Polish banking system, may cause NPLs to spike from the prepandemic average of about 7%. We think that our current assessment of the economic risk for Polish banks may not sufficiently buffer the risks.

Slovenia

We have revised our economic risk trend for Slovenia to stable from positive. In our view, income convergence with the eurozone average and improvements in asset quality will be delayed by the

COVID-19-related deterioration in economic conditions. Therefore, we no longer expect Slovenia to meet all the conditions for a better economic risk assessment in the medium term. We consider that our current assessment of risks for the Slovenian banking system can buffer for the difficult operating conditions. We take into account strong deleveraging and improvements in asset quality in the private sector in recent years. Additionally, we regard banks' capitalization and profitability as solid, and we anticipate that these will provide adequate buffers to absorb higher risk costs and pressures on revenue. We also expect the liquidity stress that originated from the mandatory loan moratorium and increased loan extension will be manageable for Slovenian banks, given their solid liquidity buffers and the central bank's support measures.

South Africa

We have revised down our BICRA score for South Africa to group '6' from group '5'.

We expect South Africa's already contracting economy will face a further sharp COVID-19-related downturn in 2020, and that the pandemic will create additional and more substantial headwinds to GDP growth due to a strict domestic lockdown, a markedly weaker external demand outlook, and tighter credit conditions.

We anticipate the banking sector will contract as a result of the economic crisis. We forecast credit to the private sector will shrink by about 5% in 2020, while we expect very low-single-digit growth in 2021.

The negative economic risk trend reflects our expectation of a sharp economic contraction in 2020, exacerbated by volatile portfolio flows. We expect sector credit losses will rise to about 1.2% in 2020, compared with 0.7% in 2019, mostly affecting retail and SME loans. Domestic households pose a significant source of risk for banks, because of their relatively high leverage and low wealth levels compared with other emerging markets. Household debt metrics, including affordability, will come under pressure in 2020 despite a decrease in interest rates. In addition, we expect stress in the commercial real estate sector on the back of a prolonged economic lockdown and the gradual reopening of the economy.

The stable industry risk trend reflects early adoption of global best practices, effective and proactive regulation and supervision, and good capitalization. The recent regulatory measures toward capital relief and liquidity support are positive for the sector and in line with measures taken by European regulators. These measures will, in turn, support the stability of the banking sector funding and capitalization, despite pressure on profitability stemming from higher impairments.

Spain

We have revised our economic risk trend for Spain to negative from stable due to the much more challenging economic environment that Spanish banks will face over the next couple of years. Until the start of March, Spanish banks were fully engaged with the same two key themes that have been paramount in recent years: strengthening balance sheets and focusing on improving returns amid relatively benign economic conditions; and identifying how to refine business and operating models in the face of the looming risks and opportunities of the digital era. For the short term at least, the COVID-19 pandemic has changed (almost) everything. In addition to the human cost, large parts of economic activity in Spain have ground to a halt. With isolation strategies still very much in force (Spain is heading for a two-month lockdown) our economists expect a sharp economic contraction in the second quarter of 2020, followed by a rebound starting in the third quarter. However, they are now more cautious on the strength of recovery through end-2020 and into 2021, envisaging that GDP in Spain will contract by 8.8% in 2020 and expand by 5.1% in 2021. It will take time for some sectors that are relevant for the Spanish economy, such as tourism, to recover, while the comparatively higher share of temporary workers in Spain will probably lead to a greater increase in the number of unemployed compared with other countries. Indeed, we forecast unemployment to increase to 16.4% by end-2020, up from 14.1% in 2019, and barely changing in 2021.

United Arab Emirates

We have revised both our economic risk trend and our industry risk trend for the United Arab Emirates (UAE) to negative from stable. The drop in oil prices and lower economic activity due to COVID-19 will lead to a rise in problem loans and the cost of risk for banks in the UAE in the next 12-24 months. We view favorably the UAE Central Bank's recently announced Targeted Economic Support Scheme, which should help to ease commercial enterprises' financial positions. However, alongside increased forbearance, this could potentially delay the full recognition of asset quality deterioration at UAE banks. Moreover, we note the relaxation of certain prudential requirements; for example, the cap on real estate exposures and the increase in loan to value limits, and see some risks of lower recognition and disclosure of problematic assets. We also see the risk of a potential weakening of transparency in the recognition and disclosure of problematic assets.

U.K.

We have revised our economic risk trend for the U.K. to negative from stable. We expect systemwide domestic loan losses to be a key indicator of the evolution of this negative trend. Specifically, we estimate that the domestic loan loss rate could rise to 100 bps in 2020, which would be around five times the level we have observed in each of the past six years. We assume that in 2021, on the back of the economic recovery, the systemwide loss rate would fall to around 67 bps, which we judge to be closer to, but still slightly above, the long-run U.K. average. We form these estimates after taking into account the U.K.'s fiscal and monetary countermeasures, and by balancing our economic forecasts with Bank of England stress test data and actual stressed loss data that we have observed over the past 30 years. While the loan loss rate is an important indicator of asset quality stress in the banking system, we will also take into account the pace and strength of the economic recovery, among other factors.

Uzbekistan

We have revised our economic risk trend for Uzbekistan to negative from stable. In our view, the economic and financial consequences of the COVID-19 outbreak will have a negative impact on Uzbekistan's economy and test the resilience of its banks. We have revised down our 2020 base-case GDP growth forecast for Uzbekistan. We now expect the economy to grow by only 1% (down from 5.5% previously), reflecting the hit to domestic and external demand from COVID-19 containment measures. We believe that Uzbekistan's economy will absorb the current shocks and will likely return to growth at 5% on average in 2021-2022. At the same time, the downside risks in our base-case forecast remain. What COVID-19 means for economic outcomes remains unclear, and could be worse than we currently assume. The speed of the recovery will also depend on policy measures to cushion the blow and limit economic dislocation, and to support the economy and households.

Chart 1

About 64% of all outlooks on bank ratings in EMEA are stable, only 3% are positive, and almost 32% are now negative (compared with 71% stable and nearly 17% negative last quarter). In Western Europe, almost 53% of ratings have stable outlooks, with negative outlooks accounting for almost 43% of ratings, and positive outlooks accounting for nearly 4% of all ratings. For emerging market banks in EMEA, about 83% of ratings have stable outlooks, with negative outlooks accounting for nearly 14% of ratings, and positive outlooks accounting for nearly 2% of all ratings.

Chart 2

Table 2

Table 3

Recent Rating Actions: EMEA Banks

Table 4

Recent Rating Actions/Resolution Counterparty Ratings: EMEA Banks

On April 19, 2018, we published a criteria article, "Methodology For Assigning Financial Institution Resolution Counterparty Ratings" (the RCR criteria) and an associated guidance document "Guidance/Criteria/Financial Institutions/General: Methodology For Assigning Financial Institution Resolution Counterparty Ratings," which is intended to be read in conjunction with the RCR criteria.

Subsequently, we assigned resolution counterparty ratings (RCRs) to selected European banks that we expect to be subject to an effective bail-in resolution if they reach the point of nonviability. This is to reflect the fact that in a resolution scenario, certain banks' liabilities will be excluded from bail-in, and therefore will have a lower default risk than traditional senior obligations. Over the past quarter, we have assigned RCRs to the selected European banks in table 5 below.

Table 5