Spotlight on main European banks’ credit risk

Mon 02 Jan 2023

After two years marked by the Covid-19 crisis, the first half of 2022 offered the prospect of a return to a certain economic normality. However, the outbreak of war in Ukraine combined with a deteriorating economic environment have reshuffled the cards and once again brought banks into a zone of turbulence and uncertainty.

So how do the major European banks reflect this new context in their expected credit losses (ECL) in their 30 June 2022 financial reports?

A continued decrease in credit risk

Credit risk as of 30 June 2022 shows a continued decrease since the peak of the Covid-19 crisis despite a reversal of the trend in H1 2022.

While the performance of banks in H1 2021 was marked by a significant decrease of the averaged net ECL charge in profit and loss compared to H1 2020, the trend has reversed in H1 2022 as banks increased their ECL charge compared to H1 2021.

A sample analysis of 26 European banks in a recent Mazars study shows that the net ECL charge absorbs on average 21% of the operating result (before ECL charge) in H1 2022 compared to 18% in YE 2021. Although increasing, this ratio remains close to its YE 2019 level of 19% compared to the increase of the average period YE 2020-2021, where it stood at 54%.

In addition, only two banks out of 26 have a net ECL profit in H1 2022 compared to nine banks in H1 2021, suggesting an increased credit risk when compared to H1 2021.

However, this increase in the average net ECL charge has not resulted in an increase of the amortised cost loans coverage ratio. This ratio is obtained by dividing the amount of ECL allowances provided for in the balance sheet by the gross carrying exposure of amortised cost loans. The average ECL coverage ratio of Amortised Costs loans (AC loans) stands at 1.42% in H1 2022 compared to 1.54% in YE 2021.

This result may appear paradoxical and is explained by, firstly, a global increase of gross credit exposures in the denominator of the ratio (average +3%) compared to YE 2021. Secondly, a global decrease of ECL allowances in the numerator of the ratio (average -4%) compared to YE 2021.

On a broader time scale, this ratio has been steadily decreasing since the YE 2020 when it stood on average at 1.83%, to the point where it is now, below the pre-crisis covid level at the end of 2019 (1.57%).

Figure 1: Amortised cost loans coverage ratio changes YE 2019 – H1 2022

The first lesson of the Mazars study therefore shows a general decrease in the level of credit risk on the long run since YE 2019, despite a global increase in the net ECL charge in the H1 2022.

A reallocation of ECL allowances by stages

As the gradual exit from the Covid-19 crisis context has resulted in a general decrease in coverage rates, a more detailed analysis of ECL allowances by stages shows that this decrease is mainly driven by loans at amortised cost classified in stage 2 and stage 3, whereas the S1 coverage ratios remained stable compared to YE 2021.

This trend is consistent with the analysis of the changes in allocation between stages: the relative decrease in the weighting of S2 and S3 gross carrying exposures to the benefit of S1 gross carrying exposures between YE 2021 and H1 2022 is reflected in the decrease in the weighting of S3 ECL allowances, as demonstrated in the figures below.

Although striking at first glance, the amplified decrease in the weighting of S3 ECL allowances compared to gross carrying exposure (GCE) is consistent as the average S3 AC loans coverage ratio is much higher than that of S2 and S1, at ten times more than S2 and 180 times more than S1 respectively.

Figure 2: Changes in AC loans – GCE by stage H1 2022 vs YE 2021 (bps)

Figure 3: changes in ECL allowances by stage H1 2022 vs YE 2021 (bps)

To sum up the second lesson of the Mazars study, a more detailed analysis of the changes in credit risk in terms of stages show that the global average decrease of ECL allowances observed is mainly driven by the decrease in S3 gross carrying exposures and an amplified decrease of the related ECL allowances.