S&P Global Rating believes that banks in EMEA will remain resilient in the months ahead. Indeed, we now project that asset quality will weaken less than we previously expected and certainly far less than during the global financial crisis in 2009. Underpinning our views are the rollout of vaccines, falling COVID-19 case numbers, and extensive policy support, which have strengthened the economic rebound across Europe, the Middle East, and Africa (EMEA). However, negative interest rates are likely to persist in the eurozone well into 2024, undermining profitability for many banks in the region, operating in overbanked markets.

We think EMEA banks face the following key risks in the next two years:

• Interruption or reversal of the recovery. This could arise because vaccination campaigns are far from complete, uneven across the region, with a risk of vaccine-resistant new variants arising. Moreover, a premature or overly abrupt phaseout of fiscal stimulus could result in higher asset quality problems for banks than we currently anticipate, higher provisioning needs, and weaker profitability. When and how to rebalance policy settings are two big questions for decision-makers across the region that might affect the banking sector.
• Limited success in revamping their operating models, adapting quickly to an increasingly digitalized word, and improving profitability. Banks' capacity to build up capital internally and externally, and ultimately their ability to effectively channel credit to the economy, will depend on their ability to transform their business processes efficiency to adjust to a highly competitive and rapidly changing operating landscape.
• A reversal of today's favorable market conditions, ultimately increasing funding costs for governments, companies, and banks--or causing greater difficulties in accessing funding. This could happen either because continued inflationary pressures will eventually require a shift in extremely accommodative monetary policy or because of a turn in investors' risk appetite.
• Distortion of risk pricing and the buildup of asset bubbles, particularly in the property market, as a result of prolonged accommodative monetary policy and excess savings.

We recently reviewed a number of our ratings on banks in EMEA, including on about 60 European banking groups domiciled in 10 European countries. As a result, our rating outlook bias is now predominantly stable instead of markedly negative.   We revised outlooks on many EMEA banking groups to stable from negative, but also downgraded a small number of financial institutions where our ratings did not already fully reflect the issues they face over the near two to three years (77% of ratings on EMEA banks had stable outlooks as of July 1, 2021, versus 61% on April 1, 2021; see chart 3). Among those are about 60 banking groups domiciled in Austria, Belgium, France, Germany, Ireland, Italy, The Netherlands, Poland, Spain, and the U.K. These rating actions also reflect our revised view that risks are gradually stabilizing for the region's banks (see table 1).

Table 1

Apart from further asset quality weakening in 2021, we consider that downside risks have been lessening for EMEA banks, supporting profitability and capitalization.  We project that the vast majority of European banks will report an improvement in financial results for 2021. We believe that credit impairment charges will start normalizing, and a rebound in economic activity across the region could gradually improve fee and commission income.

We see returning demand for credit from households as a main credit growth driver in 2021. There is evidence of growing mortgage demand in a few countries, and consumer lending is likely to rebound gradually as private consumption takes off after more than a year of excess saving and deleveraging. At the same time, we recently observed a gradual reduction in accumulated customer deposits in certain markets, which might also support retail lending prospects. While we saw some demand for new lending in 2020 from corporate borrowers--including under government-guaranteed support schemes--this was a short-lived trend, in many markets they did not fully tap these funds. Moreover, corporate lending growth has been decelerating in some markets of the region in the past few months because many companies have been deleveraging and have not yet resumed their investment plans.

We expect problem loans to further increase, particularly in banks' corporate loan books. Nevertheless, better economic prospects ahead should support borrowers' creditworthiness, resulting in a manageable increase in nonperforming assets at most banks. Asset quality performance will vary across banks and countries. It will be noticeably weaker in the sectors most vulnerable to social-distancing measures, such as transportation, hospitality, entertainment, and retail.

Net interest income will remain weak. A rebound in corporate lending growth will take time, while the recovery in mortgage lending only somewhat support banking margins, given persistently low interest rates and competitive mortgage markets. Overall, bank performance across EMEA could be somewhat more buoyant, at least on the surface, in 2021.

Recent bank downgrades and longstanding negative outlooks reflect weaker business models.  Along with gradual stabilization of the operating environment for banks in EMEA, we note digitalization, low policy rates, and shallow yield curves continue to test some banking sectors, businesses, and operating models. Across these diverse banks and markets, we see diverging profitability trends and credit stories.

Sectors like those in Sweden and Norway tend to benefit from relatively high market concentration, existing strong efficiency, and rapid adoption of digital technologies by customers. In the U.K., Belgium, and The Netherlands, we see these factors as less compelling strengths, but nonetheless generally likely to deliver cost of capital. This is less the case for players that lack scale or differentiated propositions that offer a sustainable competitive advantage. We see deeper problems in other markets, notably Germany and France, but also Italy and Spain.

Banking sector capitalization should gradually normalize from highs in 2020.  Regulatory capital ratios as of end-2020 were high for many banks because of temporary restrictions on dividend payments and capital distributions that many regulators in EMEA introduced. Ratios will likely normalize as regulators start to cautiously relax these limitations and banks resume dividend payment programs. Plus, with a moderate risk appetite in 2021 and substantial provisions for potential pandemic-related losses (created in 2020), in our view banks across the region are set to return to more normal operating conditions.

Credit conditions in emerging markets continue improving.  Credit conditions in emerging markets continue improving. Emerging economies on average are recovering faster than we previously expected. We recently raised our forecasts for GDP growth in 2021 for Russia (to 3.7%) and South Africa (4.2%), and we maintain our forecast 6.1% growth for Turkey. The reasons for this are sustained economic recovery in developed countries and in many cases improving domestic demand as activities in emerging economies resume. Notably, the economic fallout from intermittent pandemic-related lockdowns hasn't been as severe as from initial social-distancing measures in early 2020. However, downside risks remain. These are some of the additional challenges banking sectors in EMs face:

• Achieving herd immunity through vaccination is important to economic recovery and consumer and business confidence. Russia and South Africa were recently hit by a third wave of the pandemic. At the same time, vaccination levels in emerging economies are lagging those in more developed countries and diverging widely (see chart 1), representing an additional risk to the recovery of small and midsize enterprises, travel, retail, and services.
• A rapid adjustment in U.S. interest rates and persistent inflation, which could worsen financing conditions.
• Escalation of geopolitical tensions, for several emerging markets in the region. The potential for new sanctions on Russia remains, despite recent talks with the U.S. The Belarusian banking sector faces intensifying sanctions from the EU and the U.S. following disputed presidential elections in August 2020, which we consider to be manageable for banks for now. The potential reinstatement of the Iran nuclear deal in 2021, while broadly positive, will nevertheless continue to be a source of tension for Israel and Saudi Arabia. Turkey's increasing regional ambitions have also ruffled feathers within the region, even with long-standing allies.

Chart 1

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 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 2

Selected Research

We recently published several articles highlighting our views on EMEA banking sectors:

• Three Belarusian Banks Affirmed At ‘B/B’ Despite New EU Sanctions; Outlooks Remain Negative, July 6, 2021
• Omani Banks’ Economic Environment Is Stabilizing, July 6, 2021
• The Global Sukuk Market Is Returning To Traditional Risks, July 5, 2021
• Banking Industry Country Risk Assessment Update: June 2021, June 29, 2021
• FAQ: Assessing Bank Tier 2 Contingent Capital Instruments Under The Hybrid Capital Criteria, June 28, 2021
• Comparative Statistics: Top 25 U.K. Banks, June 28, 2021
• As Near-Term Risks Ease, The Relentless Profitability Battle Lingers For European Banks, June 24, 2021
• Various Rating Actions Taken On Spanish Banks Amid Proven Resilience And Industry Challenges, June 24, 2021
• Various Rating Actions Taken On U.K. Banks On Recovering Economy, June 24, 2021
• Various German Banks Downgraded On Persistent Profitability Challenges And Slow Digitalization Progress, June 24, 2021
• Various Rating Actions On French Banks As Easing Macroeconomic Downside Risk Is Dampened By Structural Profit Pressure, June 24, 2021
• Easing Economic Risks And Structural Profitability Issues Prompt Rating Actions On Seven Austrian Banks, June 24, 2021
• Two Belgian Bank Outlooks Revised To Stable On Economic Recovery As Pandemic-Related Problem Loans Loom, June 24, 2021
• Outlook On Several Dutch Banks Revised To Stable On Macroeconomic Recovery Prospects, June 24, 2021
• Ratings On Irish Banks Affirmed Amid Ongoing Profitability Pressure; Most Outlooks Still Negative, June 24, 2021
• Ratings On Three Polish Banks Affirmed Upon Resilience To The Pandemic; Outlook On Alior Bank To Stable, June 24, 2021
• Outlooks On Three Uzbekistan-Based Financial Institutions Revised To Stable After Similar Action On Uzbekistan, June 08, 2021
• The Basel Capital Compromise For Banks: Better Buffers, Elusive Comparability, June 3, 2021
• Starting Points For Rating Banks’ Nondeferrable Subordinated Debt: June 2021 Update, June 3, 2021
• Calculating The Cost Of Lebanon’s Bank-Sovereign Doom Loop, May 24, 2021
• External Auditing Of Sharia Compliance Will Likely Strengthen Governance In Islamic Finance, May 24, 2021
• Rising External Pressures Lead To Wider Economic Imbalances For Kenya’s Banking Sector, May 20, 2021
• ESG Factors Are Increasingly Influencing Banks In Russia And Neighboring Countries, May 17, 2021
• Islamic Finance Is Still Finding Its Feet In North Africa, May 12, 2021
• Hybrid Equity Content When A Call On LIBOR Fallback Is Likely, May 10, 2021
• How Much Would A Sovereign Default Cost Tunisia’s Banks? May 10, 2021
• Vision 2030 Will Push Forward Saudi Arabia’s Debt Capital Market, May 4, 2021
• Various Rating Actions Taken On Five Greek Banks Following Sovereign Upgrade, April 27, 2021
• Capital Markets Revenue Should Remain Robust For Global Banks In 2021 Despite Risks, April 8, 2021
• Various Rating Actions Taken On Uzbek Banks On Resilient Performance Despite The Pandemic’s Impact, April 6, 2021

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 several 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: Digital Wallets Will Replace Cash In Pockets, June 14, 2021
• Tech Disruption In Retail Banking: CEE Banks Are On The Digital Fast Lane, May 6, 2021
• The Future Of Banking: One-Click Deposits (Risks Included), April 8, 2021
• The Future Of Banking: Research By S&P Global Ratings, April 8, 2021
• The Future Of Banking: Cryptocurrencies Are Still Mostly About Speculation, Not Payment, Mar. 8, 2021

Economic, Sovereign, And Other Research

• EMEA Emerging Markets Sovereign Rating Trends Midyear 2021, June 29, 2021
• Global Sovereign Rating Trends Midyear 2021: Recovery Will Be Uneven As Pandemic Risks Linger, June 29, 2021
• Economic Outlook Emerging Markets Q3 2021: Despite Rising Resilience, Vaccinations Are The Key To Recovery, June 28, 2021
• An SDR Is Born: The IMF Creates A Reserve Asset For Low-Income Countries, June 22, 2021
• Credit FAQ: GCC Funding Needs Will Fall Sharply Compared With 2020, May 26, 2021
• Property In Transition: Zooming In On The Global Office Reboot, May 6, 2021
• Economic Research: How The Capital Markets Union Can Help Europe Avoid A Liquidity Trap. April 15, 2021

Rating Methodology News

• SLIDES PUBLISHED: How Our Proposed Methodology Changes Would Apply To Financial Institutions Ratings, June 15, 2021
• Criteria | Financial Institutions | Request for Comment: Request For Comment: Banking Industry Country Risk Assessment Methodology And Assumptions, June 8, 2021
• Criteria | Financial Institutions | Request for Comment: Request For Comment: Financial Institutions Rating Methodology, June 8, 2021
• Comments Requested On Proposed Financial Institutions And BICRA Methodologies, June 8, 2021
• Credit FAQ: What’s Behind The Proposals To Update Our Financial Institutions And BICRA Methodologies, June 8, 2021
• General Criteria | Request for Comment: Request For Comment: Environmental, Social, And Governance Principles In Credit Ratings, May 17, 2021

BICRA Changes

Since we last published this report, we made the following changes to our BICRAs.

Austria

We have revised our economic risk trend for Austria to stable from negative. This reflects our view that the economic risks facing Austrian banks due to COVID-19 and associated containment measures have eased. We remain mindful that nonperforming loans (NPLs) could increase into 2022 as fiscal support measures are gradually withdrawn, but we believe the residual impact on the banking system is likely to be manageable. We expect the private sector's financial health will not deteriorate materially, and the increase in corporate bankruptcies and unemployment will be contained due to the slow and gradual phaseout of government support to most affected industries coupled with the ongoing recovery.

We have also revised our industry risk trend for Austria to negative from stable. We think that risks to the banking system stability could increase unless Austrian banks speed up their efforts to improve efficiency, focusing on both stringent cost management and revenue expansion, specifically in fee-generating operations. We think that if the Austrian banking regulator were to establish a more demanding stance to support the banking groups' transition to improve structural profitability and increase digitalization, this might add to the transformative momentum.

Belgium

We have revised our economic risk trend for Belgium to stable from negative. Belgium's macroeconomic recovery on the back of unprecedented government support, the European Central Bank's ample monetary policy support, and ongoing vaccination rollout are improving prospects for domestic banks. Consequently, we estimate that risks to asset quality and banks' capitalization are receding, even though defaults of small and midsize enterprises and larger corporates are likely to increase as government support schemes are phased out.

Greece

We have revised our BICRA for Greece to Group '8' from Group '9', and our economic risk score to '8' from '9'. We raised the long-term sovereign rating on Greece to 'BB' from 'BB-' on our expectation government policies will steer toward structural reforms, which, together with the expected deployment of EU funds, would result in improved economic performance. We believe this should boost business prospects, credit supply, and demand in Greece, and increase investor appetite for purchasing problem assets, helping financial institutions to offload them from their balance sheets. In our view, the visible increase in domestic deposits, coupled with ongoing balance sheet cleanup and monetary developments, including access to the European Central Bank's targeted longer-term refinancing operations funding, has led to improvements in funding and liquidity metrics for Greek banks.

France

We have revised our economic risk trend for France to stable from negative. We now see reduced downside risks for French banks' asset quality and capitalization given unprecedented support to the local economy from domestic and European authorities, as well as COVID-19 vaccination progress.

We have also revised our industry risk score for France to '4' from '3', and our industry risk trend to stable from negative. We believe that the industry continues to face unyielding challenges to profitability and efficiencies, exacerbated by prolonged low interest rates, intense competition, revenue erosion, and high costs. Lower profitability can lead to instability and leave the sector more vulnerable when risk costs rise if banks do not generate adequate pricing on lending.

Germany

We have revised our BICRA for Germany to Group '3' from Group '2', our industry risk score to '4' from '3', and our industry risk trend to stable from negative. We believe the pandemic has exacerbated challenges facing the German banking sector, and that German banks are now less competitive relative to global peers due to slow progress improving revenue diversification, cost structures, and digitalization. We believe that German banks operate in a highly competitive and structurally overbanked banking market, with low gross margins, and that banks' progress in improving structural revenue diversification, cost bases, and digitalization is insufficient to keep up with peers. In our view, this has widened the sector's gap with leading banking systems, such as in the Nordics.

We have also revised our economic risk trend for Germany to stable from negative. We anticipate that German banks' asset quality and capitalization will likely remain robust, supported by the German economy's resilience amid the COVID-19 pandemic.

Ireland

We have revised our economic risk trend for Ireland to positive from stable. We estimate that the impact of credit losses and NPLs should be manageable for Irish banks. Irish banks entered the pandemic with healthy capitalizations and robust liquidity profiles, owing to residents' large savings. This allowed them to set aside large provisions in 2020 for future defaults but also led to reported losses. So far, we have not observed significant deterioration of asset quality, but we expect NPLs to rise over 2021-2022 as government support to households and businesses unwinds. However, we think last year's provisioning already provides a sufficient buffer for potential losses; therefore, we project new provisions to be much lower this year and next, at between 30 basis points (bps) and 45 bps. Lower credit provisions will support profitability improvements, but not enough for returns to reach pre-pandemic levels. Moreover, average systemwide returns in Ireland are likely to lag those of peers.

Kenya

We have revised our economic risk score for Kenya to '9' from '8', and our economic risk trend to stable from negative. This reflects the higher risk of wider economic imbalances stemming from Kenya's weaker external position. We expect the country's current account deficit to average 5.4% of GDP and external debt (net of liquid external assets) to average around 240% of current account receipts through 2024. What's more, the country's GDP growth and fiscal position have also been hit by the COVID-19 pandemic.

Netherlands

We have revised our economic risk trend for the Netherlands to stable from negative. In our view, the anticipated macroeconomic rebound and the ramp-up in vaccination, together with continuous government and European Central Bank support that we expect, will wind down only gradually, reducing the downside risks for Dutch banks' operating environment.

Poland

We have revised our economic risk trend for Poland to stable from negative. The pandemic-induced downturn hit the Polish economy less than most other European countries, and we expect Polish banks to manage the associated expected increase in NPLs, even after the government's support programs expire.

South Africa

We have revised our economic risk trend for South Africa to stable from negative. This reflects our view of the relative resilience of the South African banking sector to potential downside risks such as an uneven and protracted macroeconomic recovery. We see credit losses in the South African banking industry abating over the next 12-18 months after rising sharply in 2020 because of the pandemic. We expect credit losses will start decreasing, reaching about 1.7% in 2021, from 2.1% in 2020, but remain higher than their historical levels. However, we expect the NPL ratio will increase to about 5% of systemwide loans, reflecting the gradual end of regulatory forbearance measures.

Tunisia

We have revised our industry risk trend for Tunisia to negative from stable. In our view, Tunisian banks' already weak capitalization will further decline. We anticipate profitability will deteriorate significantly amid a highly competitive and fragmented operating environment, weak economic prospects, and rising credit losses. The banking system's current structure encourages price competition because banks compete for just a few blue-chip creditworthy names. We also note that the ratio of cash to accrued interest income dropped markedly for banks during 2020 because the pandemic led to a high amount of deferred loans and debt moratoriums. Furthermore, we acknowledge that banks' exposure to the sovereign reached 83.5% of their equity at year-end 2020. These factors further erode Tunisian banks' already insufficient capital buffers. We anticipate banks' risk-adjusted capital ratios will decline below 3% and regulatory capital ratios will approach the minimum requirements.

United Arab Emirates

We have revised our economic risk score for the United Arab Emirates to '6' from '5'. The sharp economic contraction in 2020--and prospects of a protracted recovery in 2021 and beyond--will have varying effects on rated UAE banks. We expect the residential real estate sector will remain under pressure for at least another year or two because of continuous oversupply, while demand-driven weaknesses will hamper the tourism, hospitality, and aviation sectors, as well as some trading sectors. We therefore expect UAE banks' asset-quality indicators will continue to deteriorate in the next 12-24 months, as regulatory forbearance measures are gradually lifted, and that credit losses will likely remain elevated. With the aforementioned change to the economic risk score, we also revised our economic risk trend to stable from negative.

We have also revised our industry risk trend for the UAE to stable from negative. When the pandemic started, the central bank (CBUAE) acted swiftly and extended a targeted economic support scheme to banks. This included, among other measures, a UAE dirham 50 billion zero-cost funding facility and the requirement to defer some corporate exposures to preserve these companies' productive capacity during stressed market conditions. The CBUAE subsequently asked banks to be transparent and disclose the amount of deferred lending on their books, grouping it into two categories: One with a minimal impact on the activity of the corporate and another with a material impact. At year-end 2020, about 14% of total loans were deferred, including 12% in Group 1 and 2% in Group 2 (based on the data disclosed by the top 10 banks). The swift action by the central bank and the transparency around the deferred exposures underpin our decision to revise the industry risk trend.

U.K.

We have revised our economic risk trend for the U.K. to stable from negative. We believe that economic risks affecting U.K. banks are receding as the recovery gathers pace and we now project a smoother transition away from fiscal support measures. Following large impairment charges in the first half of 2020, we believe that U.K. bank earnings could benefit from releases of loan loss provisions over the remainder of this year.

Uzbekistan

We have revised our economic risk trend for Uzbekistan to stable from negative. In 2020, Uzbekistan's economy expanded despite recessions in major trading partners and the COVID-19 outbreak. We believe that risks have largely stabilized for Uzbek banks and expect business growth to continue in 2021-2022, while risks for earnings prospects and funding sustainability are less acute.

Chart 2

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Chart 4

Table 3

Table 4

Recent Rating Actions: EMEA Banks

Table 5