Bank credit risk trends show a relative decrease in high risk exposures

Thu 19 Oct 2023

Despite banks emerging from the Covid-19 crisis in reasonably good health, the war in Ukraine combined with a global energy crisis and an uncertain economic landscape have once again put the spotlight on credit risk exposures.

To better understand credit risk trends, Mazars conducted an analysis of 26 banks in 11 European countries in May 2023, based on the banks’ year-end 2022 financial statements. The benchmark study on Financial reporting of European banks follows on from previous editions of the report since its launch in 2020.

When comparing the expected credit loss (ECL) coverage ratios of amortised cost (AC) loans of the main banks in our panel from France, Spain and UK to the average of all banks, we saw a consistent trend from YE 2019 to H1 2022. Despite fairly different starting points depending on the geographical area, there was an increase in AC loan coverage ratios in YE 2020, followed by a continuous decrease until H1 2022.

AC loan ratio diversity

However, practices began to diverge from H2 2022 as UK banks began to increase their global AC loan coverage ratios, while other European banks continued to reduce ratios. Part of this divergence can be explained by the different starting points possibly driven by the category of counterparties to which loans are granted, as well as cultural and other risk sensitivities. For example, at the beginning of the study, UK banks recorded very low AC loan coverage ratios compared to other European banks. Whereas from H2 2022, UK banks began to align more closely with European banks and close the gap.

In terms of the global average ECL coverage ratio of AC loans for all banks, this decreased between YE 2019 (1.57%) and YE 2022 (1.38%), with some geographical diversity in ratios in YE 2022. Notably, 2.20% for Spanish banks, 1.75% for French banks and 1.18% for UK banks, according to the study. While not part of the study, we can assume that some of the decrease in ECL coverage ratios corresponds to the end of the Covid-19 crisis.

With regard to geographical diversity in ratios, although not quantifiable, we can imply a connection with different economic forces now beginning to play a more prominent role.

Changing risk dynamics

Comparing the breakdown of ECL allowances and gross carrying exposures (GCEs) between the three stages, in terms of GCEs over the past three years, the study highlights an evolution of gross carrying amounts resulting in a significant decrease of stage 1 and stage 3 GCEs.

In terms of average figures recorded in our latest study:

• Stage 1 represents 88.7% of GCE and 13.5% of ECL allowance of AC loans in YE 2022 versus 91.3% and 10.2% respectively in YE 2019.
• Stage 2 represents 8.8% of GCE and 26.4% of ECL allowance of AC loans vs respectively 6.1% and 16.7% in YE 2019.
• Stage 3 represents 2.5% of GCE and 60.1% of ECL allowance of AC loans in YE 2022 vs respectively 2.6% and 73.1% in YE 2019.

In addition, if we contrast stages of AC loan coverage ratio between YE 2019 and YE 2022 the study reveals that stage 1 and stage 2 AC loan coverage ratios increased by respectively 4 bps and 35 bps, or 24% and 10% respectively in relative changes. Stage 3 AC loan coverage ratios decreased by 240 bps, representing a 6% relative change.

Clear trends emerge

Regarding the allocation of ECL allowances, changes over the past 3 years show a clear and homogeneous trend with a significant decrease of stage 3 in favour of stage 2 and to a lesser extent stage 1 exposures.  However, it’s worth pointing out that the changes in ECL allowances should be viewed in the context of the composition of individual bank loan portfolios. This trend is particularly illustrated by Italian banks that experienced a significant decrease of both stage 3 GCE and ECL allowances due to their Non-Performing Loans (NPL) deleveraging program.

In forthcoming studies, it will be interesting to note how banks’ ECL coverage ratio of AC loans adapts to future changes to risk dynamics both geographically and globally.