The European Banking Authority (EBA) expects that the increase in coverage ratios in Cyprus may lead to a higher reduction in non-performing loans (NPLs) in the coming quarters, something that was also observed in banks of other European countries.
In its Risk Assessment Report for November, the EBA says that an analysis of the short term historic time series shows that a sudden increase in coverage ratios at bank level is usually followed by a higher reduction in NPLs in the following quarters.
“For example, this was noticed in banks in Croatia, Romania and Slovenia. If this trend continues a similar pattern may unfold for Cyprus in the following quarters,” the report says.
At the same time the EBA pointed out that some countries more severely affected by the sovereign debt crisis still have high encumbrance levels, but markedly declining compared with last year (from 22 per cent to 6 per cent in Cyprus, from 47 per cent to 41 per cent in Greece).
However, it adds that due to the relatively low volume of assets in these countries, the decrease had only a marginal effect on the EU aggregate encumbrance ratio.
According to the EBA, the average coverage ratio in the EU has increased by 1.1 pp since June 2016 to 45 per cent, while in the first half of 2017 the rise has been marginal (+0.2 pp). The upward trend of the ratio has been once again driven by a more pronounced reduction in the denominator (total NPLs) than the reduction of the numerator.
Nonetheless, coverage ratios still differ across EU countries with values ranging between 26 per cent and 68 per cent.
According to the EBA, EU bank profitability has continued to improve. As of June 2017, the average return on equity (RoE) reached 7 per cent, 130 bps higher than in June 2016 and the highest level since 2014. Despite the increase, the current level of RoE still remains below the cost of equity, pointing to a risk that this could be an unsustainable business model in the long term.
In some countries, profitability is still lagging behind due to two main factors. In countries such as Greece, Croatia, Cyprus and Portugal, banks are less profitable, mainly because of their high impairments; impairments are also dragging down profits in Spain and Italy.
In Germany and France, as well as Austria, operating expenses significantly affect banks’ ability to generate net income efficiently, in order to thrive in the future.
Other countries (Bulgaria, Czech Republic, Hungary and Romania) are far more profitable than the average; their profitability has been driven by net interest income, low impairments and, for most of them, low cost income ratio.