Asset quality and earnings are expected to take a significant hit from the effects of the Covid-19 outbreak, but banks’ robust capital and liquidity positions heading into the crisis should enable them to weather the shock, the European Banking Authority (EBA) says.
In a new report outlining its initial assessment of the impact of the pandemic on the European banking sector, the EBA said that banks entered this latest crisis in a much better position than they did the global financial crisis.
Banks’ common equity tier 1 capital ratios were almost 15% by the end of 2019, up from 9% in 2009, including an average buffer of about 3% of risk weighted assets (RWAs), the EBA said.
Banks’ liquidity coverage ratios were significantly above their regulatory minimums too, the EBA found.
Regulators’ efforts to mitigate the effects of the Covid-19 crisis have freed up capital to absorb the economic shock, the EBA said.
Nonetheless, the EBA said that the crisis “is expected to affect asset quality and, thus, profitability of banks.”
In particular, banks are likely to face higher troubled loan volumes and rising risk-weighted assets.
“Higher volatility on financial markets is also a concern and could further increase RWAs,” the EBA said.
However, the robust capital buffers that banks had built up should allow them to withstand the potential rise in credit risk losses.
The EBA reported that its analysis suggests that, on average, the banking sector should have enough capital to cover potential loan losses “under the most severe credit risk shock” while maintaining a buffer above their minimum capital requirements.
“The extent to which banks will be affected by the crisis is expected to differ widely, depending on how the crisis evolves, the starting capital level of each bank and the magnitude of their exposures to the most affected sectors,” the EBA said.
Additionally, pre-existing weaknesses, such as low net interest margins, “might be exacerbated by the low interest rate environment, which will now persist for even longer,” it said.
As a result, the pressure to consolidate could ramp up too, the EBA said.