European banks are sitting on bad debts of €1tn – the equivalent to the GDP of Spain – which is holding back their profitability and ability to lend to high street customers and businesses.
According to a detailed analysis of 105 banks across 21 countries in the European Union conducted by the European Banking Authority (EBA), the experience of Europe’s banks to troubled customers is worse than that of their counterparts in the US.
The €1tn (£706bn) of so-called non-performing loans amount to almost 6% of the total loans and advances of Europe’s banks and 10% when lending to other financial institutions are excluded. The equivalent figure for the US banking industry is around 3%.
Piers Haben, director of oversight at the EBA, said that while the resilience of the financial sector was improving because more capital was being accumulated in banks, he remained concerned about bad debts. “EU banks will need to continue addressing the level of non-performing loans which remain a drag on profitability,” Haben said.
Banks in Cyprus have half their lending classified as non-performing while in the UK the figure is 2.8%.
Capital ratios – a closely watched measure of financial strength –had reached 12.8% by June 2015, well above the regulatory minimum, as banks held on to profits and also took steps to raise capital - for instance, by tapping shareholders for cash. In 2011, the figure was 9.7%.
The UK’s banks covered by the survey – Barclays, HSBC and the bailed-out Royal Bank of Scotland and Lloyds Banking Group – hold 11.8% of capital, below the EU average.
The EBA also published data on the leverage ratio, which is regarded as a very pure measure of financial strength as it does not take into account the risks being taken. This showed that of the four UK banks included in the sample, Barclays has the lowest leverage ratio at 4%.
The EBA is not conducting health checks on banks for 2015 as it did in 2014, when 24 banks - none of them from the UK - failed the test.
But the Bank of England is assessing the health of the UK’s lenders and will publish the results on Tuesday, when their ability to withstand a dramatic slowdown in China, a contraction in the eurozone and the worst deflation since the 1930s will be announced.
To fend off criticism from banks that being forced to hold more capital impedes their ability to lend, the EBA said capital ratios had increased by 3.3% in the first half of 2015 while lending had increased by 3.9%, some €74bn. It said: “This underpins the idea that better-capitalised banks are in a better position to increase the flow of lending to the real economy.”
“An increase in cross-border lending is also evident,” the EBA said, in contrast to the eurozone crisis, when banks had hunkered down and channelled their lending to domestic companies and individuals.
“The increase in lending has been accompanied by a very gradual improvement of asset quality, although levels of non-performing exposures in EU banks remain a concern and a potential impediment to lending growth and profitability,” the EBA said.
The EBA said the profitability of banks was improving in the wake of the financial crisis, but was still low by historic standards. This presents a challenge for ongoing efforts to strengthen the banking industry, not only in the wake of the 2008 crisis but also the fears of near-break up of the eurozone in 2012.
The regulator considered a number of reasons for the slow growth in profits. As well as bad debts, the EBA pointed to the cost inefficiencies and the cost of so-called conduct issues, such as fines, compensation and legal costs, which absorb almost 4% of banks’ operating income.
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