On 25 May 2020, the European Banking Authority (EBA) published a preliminary assessment of the impact of COVID-19 on the EU banking sector.
The EBA reports that the COVID-19 pandemic is expected to affect asset quality and therefore the profitability of banks going forward. However, it also notes that the capital accumulated by banks during the past years together with the capital relief provided by regulators amounts on average to 5p.p. above their overall capital requirements (OCR). This capital buffer should allow banks to withstand the potential credit risk losses derived from a sensitivity analysis based on the 2018 stress test.
In terms of the COVID-19 pandemic having a negative impact on asset quality, the EBA states that banks are likely to face growing non-performing loan (NPL) volumes, which can reach levels similar to those recorded in the aftermath of the sovereign debt crisis. A sensitivity analysis based on the 2018 EBA stress test suggests credit risk losses could amount up to 3.8% of risk weighted assets (RWAs). The banking sector would on average count on enough capital to cover potential losses under the most severe credit risk shock while maintaining a buffer equivalent to 1.1p.p. of RWAs above their OCR. State guarantees introduced in many jurisdictions might soften this impact while EBA guidelines on loan moratoria will avoid automatic classification of affected exposures as forborne or defaulted.
The EBA also notes that banks’ operational resilience is under pressure. Following the outbreak of the pandemic, banks have activated their contingency plans, which have allowed them to keep their core functions broadly unaffected. However, the handling of large volumes of applications for debt moratoria and guaranteed loans, and the insufficient preparation of some offshore units to work remotely has added some pressure on their operational capacities.