EBA publishes report on risks and vulnerabilities of the EU banking sector

The European Banking Authority (EBA) published today its fourth semi-annual report on risks and vulnerabilities of the EU banking sector. The report identifies improvements in market confidence, funding and capital positions. However, it cautions about ongoing uncertainties on asset valuations and future profitability in a fragile economic environment. The report also draws attention to the risks of detrimental business practices and puts forward possible measures for addressing such vulnerabilities through coordinated policy and supervisory actions.

Throughout the second semester of 2013, the EU banking sector observed overall improvements in market confidence from both debt and equity investors, with several indicators showing that confidence is returning. Funding conditions improved across the EU, in connection with an increasing demand from EU and non-EU investors for European bank debt. EU banks continued to strengthen their liquidity and funding positions by attracting more deposits. Nonetheless, the persistent high reliance on central bank funding, the side-effects of monetary accommodation and the existence of a weak macroeconomic environment, remain matters of concern.

Following the EBA's recapitalisation exercise, capital levels have continued to improve, despite the challenging conditions in financial markets, and are now in line with major international peers, as shown in the EBA's latest transparency exercise.

On the contrary, the continuous deterioration of the quality of banks' loan portfolios, as well as low profitability levels, may pose challenges in maintaining adequate capital levels. Uncertainties about asset valuation were found to persist and remain a fundamental issue in the EU, heightening the need for rigorous Asset Quality Reviews (AQRs), with consistent definitions across the EU. The EBA recommendation on the need to conduct AQRs across major EU banks and the publication of the final draft Technical Standards on supervisory reporting on forbearance and non-performing exposures in October 2013 are preconditions for reliable AQRs. Banks are taking pre-emptive actions ahead of the supervisory actions resulting from the AQR, focusing on quantitative assessment of provisions, collateralisation and the values of exposures.

EU bank's profitability continued to face significant headwinds, which are not likely to dissipate in 2014. The low interest rates environment creates pressure on bank net interest margins and earnings may not be sufficient to cover rising bad loans, leaving question marks over some banks' future profitability and viability. The need for bank restructuring and changes to business models will remain a key challenge and it is fundamental that supervisors create a more coordinated and robust analysis of banks' business models across the EU.

Some uncertainties also remain in view of the entrance into force of the new regulatory framework, with significant strategic and implementation challenges, as well as the developments on bail-in requirements. The institutional reforms at EU level are key to breaking the sovereign-bank pernicious linkage, in particular the establishment of the banking union, including the creation of a more integrated framework for bank resolution and a single deposit guarantee scheme.

A number of detrimental business practices of EU banks have also affected consumer confidence and increased reputational risks linked to the relationship between banks and consumers. As well as reputational risk, the potential prudential impact of conduct-related redress remains a concern. This will require heightened supervisory oversight and improvements in institutions' risk management functions, and a more general reassessment of the relationship between banks and their customers.

A coordinated policy action remains fundamental for the coherence of the single market. The EU banking sector continues to be fragmented and the need for continued regulatory and supervisory convergence across the EU will remain a key challenge for the EBA.

Legal basis and next steps

This report provides an update on risks and vulnerabilities in the EU banking sector. With this report and that prepared in July 2012, the EBA discharges its responsibility pursuant to Recital 43 of Regulation (EU) No 1093/2010 of the European Parliament and of the Council of 24 November 2010 to monitor and assess market developments and provide information to other EU institutions and the general public.