“New credit risks have not as yet materialised for banks, but emerging risks are adding to vulnerabilities identified before and during the pandemic,” said Nicolas Hardy, Scope’s deputy head of financial institutions. “As interest rates rise, new cohorts of vulnerable borrowers will emerge as banks adjust their origination criteria and pricing. This is likely to have a pro-cyclical effect on asset-quality metrics.”

“The prolonged period of abundant liquidity and low interest rates, meanwhile, has increased the risk of a damaging correction in some market segments and industry sectors,” Hardy added. The ECB has warned repeatedly about growing risks in leveraged finance. Other sources of vulnerability include the continuing increase of credit to the private sector and volatile equity markets.

New vulnerabilities are emerging for sectors and borrowers most exposed to inflationary pressures, for instance in relation to energy prices, food and other raw materials. The pressure is not contained to specific sectors, making it more challenging to quantify the impacts. On Russia and Ukraine, direct credit exposures are manageable but understanding which counterparties are exposed to the indirect effects of the war or to the evolving regime of sanctions is unclear. But while these pockets of risks are a concern, there are several positive signs.

“Higher rates will support banks revenues, while the massive clean-up of banks’ balance sheets in recent years has created room to absorb new NPL inflows,” Hardy said. NPL stocks of large European banks have fallen by over 60% since 2015 from EUR 1trn to EUR 373bn.“Also any increase in NPLs will be gradual, giving banks time to take proactive measures, including NPL portfolio sales and securitisations. Rising NPLs will not necessarily mean higher NPL ratios for European banks.”

Download Scope’s Asset-Quality Review here, including chart-rich break-out sections covering banks in Austria and Germany, Belgium and Netherlands, France, Italy, the Nordic region, Spain, and the UK.

Access all Scope rating & research reports on ScopeOne, Scope’s digital marketplace, which includes API solutions such as Credit Sphere.