ECB warns of rising loan losses and tightening funding for eurozone banks

The European Central Bank has warned that eurozone banks risk accumulating bad debt and a funding crunch due to rising interest rates, rising inflation and a likely recession.

ECB supervisors are planning more frequent inspections of bank offices and will carry out “more targeted reviews” of the biggest lenders in the single currency area of ​​19 countries to push them to deal with these growing risks, the regulator.

Publish sound priorities for banking supervision next year, the ECB said lending to energy-intensive sectors, residential mortgages and commercial real estate were particularly vulnerable to a deterioration in the economic environment.

Some banks may also struggle to replace the cheap funding the ECB provided to help the sector through the coronavirus pandemic, which is now being withdrawn as the central bank tightens monetary policy to tackle high inflation, it said. he declared.

“While the banking sector has so far proven resilient to the fallout from the war in Ukraine, downside risks have increased accordingly,” said ECB supervisory board member Kerstin af Jochnick and Mario Quagliariello, its director of surveillance strategy. and risk.

“In the near term, we are concerned about the impact of the macroeconomic environment and financial market dynamics on the quality of assets and the funding of banks,” they said in a blog released on Monday.

Increased pressure from the ECB on preparing banks for a possible rise in bad loans and tighter funding could heighten tensions with industry executives, many of whom have already complained on his heavy-handed approach to supervision.

Banking sector performance has picked up this year as higher interest rates have boosted profit margins on loans, while government measures to support businesses and households facing high energy costs have helped maintain payment defaults at a low level.

However, the ECB warned that the good times looked unlikely to last due to a likely rise in bad loans and rising funding costs for banks.

The central bank should raise interest rates Thursday by at least 0.5 percentage point to 2%, which would be the highest level since the 2008/9 financial crisis, when most economists expect the euro zone to slide into recession this winter.

“Higher interest rates and the prospect of sluggish or possibly recessionary growth could challenge borrowers’ ability to service debt going forward,” ECB officials said in their blog post. “This may be particularly the case for highly indebted households and businesses.”

The central bank said a recent prudential review had identified shortcomings in the way banks control their risks, “particularly with regard to the origination and monitoring of loans, the classification of borrowers in difficulty and the frameworks of provisioning”.

Some banks have also become “more vulnerable to market disruptions” due to a heavy reliance on ultra-cheap funding from the ECB itself, the central bank has warned.

Last month the ECB changed the terms of its targeted longer-term lending operations, under which it lent 2.1 billion euros to banks at a rate as low as minus 1% to encourage them not to not reduce their loans during the pandemic.

The TLTRO rate was raised to the ECB deposit rate from last month and since then banks have repaid almost 800 billion euros of their loans under the program ahead of schedule.

The central bank said some banks should “diversify their funding sources further and replace some of their central bank funding with more expensive and possibly shorter-term alternatives, which will put pressure on their prudential ratios and their profitability”.