Nonperforming loans (NPLs) have been on a decline within the eurozone. But with support measures from central banks and governments bound to end before not too long, banks cannot allow themselves to be complacent.
NPLs across the euro area peaked at 6.5 percent, or € 1.2 trillion, in 2014. Since that high-water mark, higher credit risk management standards and newly-implemented early warning systems have led to a steady decline.
Over the past decade, banks have started looking more critically at the quality of their assets and the related control processes. And for good reason, as the downturn from COVID-19 may be more severe than anyone dared to anticipate at the beginning of this year. This means that vulnerabilities may materialize more quickly, especially considering the fact that asset quality can deteriorate much faster – and on larger scale – than traditionally accounted for.
Initial effects emerge in corporate and SME portfolios, which faced substantial liquidity challenges due to the lockdowns. But because of the extensive support from central banks and governments, there will be a lag until we see an market-wide increase in defaulted loans. Subsequently, problems with household lending will materialize once incomes drop and unemployment rates rise.
Regardless of a bank’s starting position, vigilance is required to manage asset quality. We can expect the European Central Bank to carry out ad-hoc asset quality reviews (AQRs) once this crisis draws to a close. Banks should not just be prepared for this, they should be in control long before regulators show up to their doorstep.
That is why it is important to prioritize or accelerate programs that strengthen pro-active credit management. Improving capabilities to detect and act upon signals is key, such as attaining client-level insight into their impact on the bank’s key indicators. This enables banks to take preventive measures. Standardization and uniformity are key to leveraging new technologies and reducing time between identifying and acting on certain triggers.
Banks that invest in early warning systems, forbearance effectiveness and analytical capabilities will have a head start in the post-COVID-19 world. By the same token, banks that were complacent due to past low NPL levels may be, unnecessary, caught by surprise.
For more insight on managing asset quality, download our whitepaper by clicking the link below. In this document, we focus on the implications of these developments on loan origination and management practices for Dutch banks. We present a number considerations for our clients that will help them to define and support the way forward once the worst shock has passed.