Banks across Europe, the Middle East, and Africa (EMEA) will remain broadly resilient to tightening financing conditions and high interest rates over the next 12 months. Lending growth is set to decelerate further in many European markets, but S&P Global Ratings considers that banks' earnings will remain solid and cover higher credit costs. The increase in net interest margins continues to provide tailwinds, and banks should be able to preserve their solid capitalization and funding profiles.

A robust labor market and accelerating wage growth will support real disposable income next year, easing income constraints for households and supporting consumption. However, European economic growth will remain fragile. Our GDP growth forecasts for the eurozone remain unchanged at 0.6% for 2023 and 0.9% for 2024. We now forecast inflation of 5.6% this year and 2.7% in 2024.

We therefore expect EMEA banks to face weakening asset quality over the next year, particularly when it comes to small-to-midsize enterprise (SME) loans, unsecured consumer credit, and commercial real estate (CRE) exposures. However, the impact should be manageable, with provisions normalizing rather than spiking. While we consider that EMEA banks will perform resiliently over the coming quarters, we see three main risks to our baseline assumptions:

• Market turbulence and financial instability due to more restrictive financing conditions. The European Central Bank (ECB) may accelerate the reduction of its balance sheet, shrinking banking system liquidity more quickly than we currently expect. Financial institutions with weaker funding profiles, especially nonbank financial institutions with high refinancing needs, will be more vulnerable. Increased market turbulence could also expose banks to higher counterparty credit risks. Emerging market banks, especially those that rely heavily on external debt, will also remain under pressure.

• A protracted, painful recession. This would undermine the financial health of corporates and households, thus further weakening banks' asset quality and business prospects.

• Banks' failure to achieve commercially and operationally resilient business models. This could occur if banks fail to tackle inefficiencies, further digitalize their businesses, and bolster their protection against cyber risks. Banks that work with third-party service providers that might have subpar cyber security standards compared to the banking sector are also at risk.

Nevertheless, our rating actions on EMEA banks in 2023 continue to have a pronounced positive net bias and ratings have a stable outlook bias. This reflects our view of a likely resilient performance in 2023-2024.

At the same time, tail risks from the Russia-Ukraine war remain a concern, as we now assume that the active phase of the war will extend into next year. The recent eruption of war between Hamas and Israel exacerbates already elevated global geopolitical risks.

European Markets Face Some Deleveraging, In Contrast To Many Emerging Markets

Tight funding conditions will support some deleveraging in many European markets. Several emerging markets in EMEA recovered quickly from the pandemic, enjoying relatively strong lending growth over the past two years. However, even there, tight credit conditions due to high inflation and interest rates and domestic liquidity constraints will restrict lending growth. For a few emerging markets, such as Nigeria, local-currency depreciation in 2023 contributed to nominal lending growth due to the currency revaluation of the sizable share of foreign-currency loans in the lending book.

Chart 2

Banking Systems Should Be Resilient To Severe Asset Quality Deterioration And Market Shocks

The results of the ECB/European Banking Authority stress test show that although EU banks would see capital depletion of about 459 basis points (bps) on average in a stress scenario, the majority would see their common equity tier 1 ratios remain comfortably above 10%. Only three banks would face a drop in capital below the regulatory requirement, while a further 34 banks would have to cut distributions to shareholders and holders of additional tier 1 instruments in a stress scenario. The stressed macro assumptions were harsher than in the 2021 stress test exercise, resulting in higher modelled losses.

Banks' Earnings Should Be Sufficient To Absorb Increasing Credit Losses

Although higher interest rates have boosted bank's margins, we expect the positive effects to peak this year. At the same time, the persistence of elevated rates increases the pressure on household and corporate borrowers, leading to further rises in credit costs. We estimate that credit costs for Western European banks will average 20-30 bps over 2023-2024. Although this is a deterioration from 2021-2022 levels, we view it as a normalization rather than an indicator of significant asset quality problems. Overall, we expect that banks should be able to manage higher credit costs as rising interest rates benefit their net interest margins and capital remains robust.

We believe that the strong European labor markets will support the performance of banks' mortgage portfolios. Unsecured consumer borrowers will be under greater pressure, similar to corporate borrowers (primarily SMEs) with tighter debt and affordability metrics. Negative price trends in the CRE segment could also expose banks to losses.

The Orderly Repayment Of Longer-Term Refinancing Operation (TLTRO) Borrowings Continues

TLTRO borrowings dropped by more than 70% to just below €500 billion at the end of September 2023 from €2.2 trillion in January 2022. At the same time, excess reserves that eurozone banks hold at the ECB remain high, at €3.6 trillion.

Warning Signs In The CRE Segment Could Spell Asset Quality Pressure For Some Banking Sectors

While we believe that the CRE segment performed resiliently during the pandemic-related stress in 2020-2022, it could become a source of credit risk for banks over the next few years. During the pandemic, hotels and retail properties were under the greatest pressure. This time round, the stress will likely come from a longer-term structural shift in the sector, with many corporate businesses implementing more flexible and hybrid working patterns. This could lead to a gradual decline in the demand for office space in the medium-to-long term, weighing on asset valuations and curbing cash flows. Lenders could see loan losses rise as a result.

The tighter financing conditions that we expect to continue throughout 2024 will only add to the pressure on CRE borrowers. European markets with the highest share of CRE lending in total loan book--such as Germany, Sweden, Denmark, the Netherlands, and Norway--are most exposed to the growing risk.

Geopolitical Instability In The Middle East Could Weaken Some Banking Sectors' Performance

The eruption of war between Hamas and Israel in the Middle East puts further upward pressure on our global assessment of geopolitical risk that we already view as elevated and worsening. This compounds the strain on international relations caused by the Russian invasion of Ukraine and the tense relationship between China and the U.S. For now the economic and credit impact is largely being contained to Israel, Gaza, Egypt, and Jordan, even though recent developments present a real threat to stability in the wider Middle East and add to already heightened geopolitical concerns globally. This could eventually negatively impact the business growth and profitability of some banking sectors in the region, as well as increase their funding risks.

Key Banking Sector Risks In EMEA

The table below presents S&P Global Ratings' views about the key risks and risk trends affecting the 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').

Selected Research

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

• Outlooks On Israeli Banks Revised To Negative On Increased Geopolitical Risk; Ratings Affirmed, Oct. 31, 2023
• Sector And Industry Variables | Criteria | Financial Institutions | Banks: Banking Industry Country Risk Assessment Update: September 2023, Sept. 28, 2023
• Various Rating Actions On Italian Banks On Balance Sheets' Resilience To Economic Cycles, Oct. 25, 2023
• Highlights From The European Financial Institutions Conferences 2023,Oct. 19, 2023
• Metro Bank's Rescue Deal Has No Direct Consequence For Rated U.K. Banks, Oct. 9, 2023
• The Resolution Story For Europe's Banks: Making The Regime Fit For Purpose, Oct. 4, 2023
• Tech Disruption In Retail Banking: Country-By-Country Analysis 2023: Leaders And Laggards Emerge, Sept. 27, 2023
• Large French Banks' Net Interest Income Should Pick Up From Mid-2024, Sept. 26, 2023
• SLIDES: European G-SIBs Monitor H2 2023: Rising Rates Don't Float All Boats, Sept. 20, 2023
• Swiss Public Liquidity Backstop Has Limited Implications For Hybrid Ratings, Sept. 18, 2023
• Tech Disruption In Retail Banking: Irish Banks Are Working With, Not Against, Fintechs, Sept. 14, 2023
• As Their Funding Evolves, U.K. Banks Have Flexibility, Sept. 14, 2023
• Credit FAQ: What An Acceleration Of Quantitative Tightening Could Mean For Eurozone Banks, Sept. 13, 2023
• Various Rating Actions Taken On Portuguese Banks Due To Positive Sovereign Outlook And Prospects Of Easing Economic Risk, Sept. 12, 2023
• Banks In Major GCC Economies Remain Resilient To Less Supportive Operating Conditions, Sept. 12, 2023
• Outlooks On 12 Nigerian Banks Revised To Stable After Same Action On Sovereign; Several National Scale Ratings Raised, Aug. 11, 2023
• EU Banks Resist Tough Assumptions In Latest Stress Tests, Aug. 01, 2023
• Credit FAQ: How Owner Support And Intent Influence European Bank Hybrids, July 27, 2023
• Cyber Risk Insights: Attack On Vulnerable Software Highlights Outsourcing Risk For Banks, July 21, 2023
• SLIDES: Global Banks Midyear Outlook 2023: Resilience Will Be Tested, July 20, 2023
• Credit FAQ: A Closer Look At Insulated Entities In Financial Services, July 18, 2023
• Swiss Public Liquidity Backstop For Banks Comes With Strings Attached, July 17, 2023
• SLIDES: Banks Face Rising Losses Amid Growing Risks, July 13, 2023
• Banking Industry Country Risk Assessment Quarterly Monitor: 2Q 2023, July 12, 2023
• Latest BoE Stress Test Signals U.K. Banks' Resilience To A Severe Downturn, July 12, 2023
• The Global Sukuk Market Is Showing Pockets Of Opportunity, July 12, 2023
• Sector And Industry Variables | Criteria | Financial Institutions | Banks: Banking Industry Country Risk Assessment Update: June 2023, June 30, 2023
• European Banks: Protecting Liquidity Will Come At An Increasing Cost, June 29, 2023
• Rating Actions On Three Polish Banks Reflect Differing Provisioning Needs Following ECJ Ruling, June 27, 2023
• Comparative Statistics: U.K. Banks Compete Strongly As Rates Climb, June 16, 2023
• Nigeria National Scale NOHC Ratings Affirmed After Criteria Review; Removed From Under Criteria Observation, June 15, 2023
• Credit FAQ: Key Risks For Banks In Select EMEA Emerging Markets, May 23, 2023

Economic, Sovereign, And Other Research

• Operational Resilience Is Key To Global FMIs’ Rating Strength, Oct. 4, 2023
• Economic Research: Which Emerging Markets Are More Vulnerable To A Further Increase In Energy Prices?, Oct. 4, 2023
• Future Of Banking: AI Will Be An Incremental Game Changer, Oct. 3, 2023
• SLIDES: Uneven Global Office Recovery Is Squeezing Credit Quality, Oct. 3, 2023
• Credit Cycle Indicator Q4 2023: Risks Could Intensify Before The Cycle Turns, Sept. 28, 2023
• Uneven Liquidity And Strained Valuations Are Pushing Some Funds Toward Debt, Sept. 28, 2023
• Credit Conditions Europe Q4 2023: Resilience Under Pressure Amid Tighter Financial Conditions, Sept. 26, 2023
• Credit Conditions Emerging Markets Q4 2023: High Interest Rates Sour The Mood, Sept. 26, 2023
• Emerging Markets Real Estate Issuers Stand Their Ground, Sept. 20, 2023
• Top 200 Banks: Capital Ratios Continue To Normalize After Pandemic Peaks, Sept. 18, 2023
• Global Bank Exposures To Commercial Property Are Top Of Worry List For Investors, Webcast Polls Show, Aug. 3, 2023
• Global Emerging Markets: Common Themes, Individual Circumstances, July 20, 2023
• Key Rating Metrics For Global Financial Market Infrastructure Companies (July 2023), July 6, 2023
• Economic Outlook Eurozone Q3 2023: Short-Term Pain, Medium-Term Gain, June 26, 2023
• Economic Outlook Emerging Markets Q3 2023: A Slowdown Ahead After Beating Expectations, June 26, 2023

BICRA Changes

Over the past quarter, we made the following changes to our BICRAs.

Egypt

We have revised our BICRA for Egypt to Group '10' from Group '9' and our economic risk score to '10' from '9'. The lack of progress on key monetary and structural reforms has exacerbated imbalances in the currency market, deteriorating the net foreign asset position of systemic banks and delaying the disbursements of IMF and other multilateral and bilateral financing, which in our view are critical to cover Egypt's high external funding. In addition, we view the government's high debt servicing costs as a potential challenge to debt sustainability, given rising social pressure, and limited spending capacity after interest payments. With the aforementioned change to the economic risk score, we have also revised our economic risk trend for Egypt to stable from negative.

We have also revised our industry risk score for Egypt to '9' from '8'. Banks have increased their reliance on external funding due to the lack of sufficient foreign currency in the economy. Absent Central Bank of Egypt intervention in the market to provide foreign currency liquidity, commercial banks are liquidating foreign assets and increasing borrowing from abroad, at increasing costs, to face high demand for foreign currency via official channels from households and companies.

Hungary

We have revised our economic risk trend for Hungary to stable from negative. This reflects that credit losses for Hungarian banks are likely to be lower than we originally expected, supporting banks' resilience amid the economic slowdown. Despite rising interest levels and a material increase in the cost of living stemming from high inflation, we see no material deterioration in households' credit risk. This is largely because of government measures to support the private sector, including small and midsize enterprises. Hungarian banks experienced a slight decline in nonperforming loans to 3.0% in first-quarter 2023 from 3.2% at year-end 2021. In our base case, we expect no material weakening in banks' asset quality.

Ireland

We have revised our BICRA for Ireland to group '3' from group '4', and our economic risk score to '3' from '4'. We expect Ireland to enjoy domestic economic growth of about 2.0% in 2023--outperforming many countries in the eurozone--as well as low unemployment, which, in our view, will bolster the Irish banking sector. We also anticipate that Irish banks will be broadly on track to reduce nonperforming loans to their publicly stated target levels by year-end 2023 and keep asset quality metrics around those levels. Furthermore, we project that the current high interest rate environment--as well as banks' focus on costs and their greater scale thanks to the consolidation of the domestic banking sector--will boost the resilience of domestic banks' overall creditworthiness.

Israel

We have revised our economic risk trend for Israel to negative from stable. The negative trend reflects the high level of uncertainty surrounding the negative effects of the conflict on the sector. Israeli banks have navigated several military escalations over recent decades, but current developments could be of a greater magnitude. In our view, Israeli banks might face heightened economic risks if geopolitical risks escalate further. We see a risk that banks might face protracted effects from revised macroeconomic prospects and credit conditions with a potential decline in revenue and substantial increase in credit losses.

Italy

We have revised our economic risk score for Italy to '5' from '6' and our economic risk trend to stable from positive. We expect Italian banks and, particularly, their asset quality to be more resilient than in the past to future downturns, thanks to improved underwriting, tighter risk controls, and active management of problem loans paired with historically low legacy nonperforming exposures.

Malta

We have revised our economic risk trend for Malta to stable from negative. In our opinion, sound economic fundamentals in the country are easing the risks of a sharp real estate price correction for local banks. We anticipate that Malta's economy will continue growing in the coming quarters, and that its slowdown in 2023 will be milder than peers' and its rebound more robust in 2024. We expect real GDP growth of over 3% in both 2023 and 2024, versus an average of below 1% in the euro area, largely due to tourism and gaming industry resiliency.

Oman

We have revised our economic risk trend for Oman to positive from stable. We see stronger economic resilience for Oman's banking system. Favorable oil sector dynamics coupled with higher non-hydrocarbon sector output will likely sustain the country's real economic growth over 2023-2026 and support domestic demand and the performance of key sectors such as tourism, transportation (mainly shipping), and utilities. Structural reforms such as reorganizing Oman's government-related entities have brought operational efficiencies and strengthened the financial profiles of these entities.

Poland

We have revised our industry risk trend for Poland to stable from negative. Higher interest rates have boosted operating profitability at domestic banks and reinforced their ability to absorb higher costs. The European Court of Justice ruling on June 15, 2023, indicates potentially higher provisioning needs for Polish banks with legacy mortgage loan portfolios denominated in foreign currencies. We expect that most banks can absorb these provisioning needs, given their strong operating profitability and available excess capital. Banks would have time to restore their capital positions if needed.

Portugal

We have revised our economic risk trend for Portugal to positive from stable. This reflects the country's improving budgetary and external positions. Supported by tourism and investments under large EU funds, as well as prudent policymaking, the government's fiscal policy will see net debt to GDP decline to an expected 87% at year-end 2026 from 107% at year-end 2022--one of the steepest reductions in Europe. At the same time, Portugal's overall external position continues to improve, thanks to contained import growth and booming tourism. We therefore expect that the current account balance will return to a surplus in 2023, at just over 1% of GDP. We also expect external deleveraging to continue.

Switzerland

We have revised our economic risk score for Switzerland to '1' from '2'. We expect Swiss households and corporates to maintain credit strength despite the worsening economic outlook. The labor market has been very resilient, with the unemployment rate near 20-year lows (2.2% in 2022), supporting household resilience. At the same time, we consider Swiss corporate balance sheets as healthy overall and do not project a material worsening of their credit metrics, given the high share of equity financing compared with international peers. To date, we have not seen any notable increase in insolvencies due to adverse shocks and deem the sector flexible, competitive, and well positioned to withstand the negative effects of a persistently strong Swiss franc.

We have also revised our industry risk score for Switzerland to '3' from '2'. In May 2023, the Swiss parliament commissioned an inquiry into the Swiss Financial Market Supervisory Authority (FINMA) and the Swiss Federal Council to examine the failure of Credit Suisse. Following the outcome of the parliamentary commission (expected next year), we believe further legislative changes could ensue, for example related to capital ordinance, FINMA's early intervention powers, the Swiss National Bank's role as lender of last resort, and resolution. While general regulation in Switzerland remains strong, we now regard the Swiss institutional framework as comparable with that of global peers including Austria, Germany, New Zealand, and the U.S.

Table 2

Table 3

Table 4