Bad loans and regulation will squeeze Eurozone banks in 2013

January 28, 2013

While the economic forecast for the Eurozone in 2013 shows painful progress towards stability, Eurozone banks and insurers will face another difficult year.

The north-south divide will become more entrenched this year; while the outlook for lending in northern markets is slowly improving, the outlook for southern markets is bleak as banks contend with a recession-driven glut of non-performing loans and continued regulatory pressures, according to the Ernst & Young Eurozone Financial Services Forecast (EEFSF).

  • Banks are just two-thirds of the way through deleveraging; €132b of further loan-book shrinkage expected in 2013
  • Non-performing loans to hit a Euro-era high of 7.6% in 2013
  • Consumer lending squeeze continues; while business lending forecasts highlight the north-south divide
  • Insurers profits expected to have fallen 5% in 2012
  • Growth of Asset Under Management (AUM) to be better than expected; +9.6% in 2012 and +6.5% in 2013

The outlook for non-performing loans has worsened again as credit quality in the Eurozone has deteriorated more sharply than expected. Non-performing loans are expected to have hit 6.8% in 2012 and will reach a Euro-era high of 7.6% in 2013 (up 1% from the previous forecast).

Andy Baldwin, Financial Services Leader for Europe, Middle East, India and Africa at Ernst & Young, says:

“While the economic outlook is marginally better than at the beginning of last year, financial services firms — in particular banks — will be hit by the cumulative effect of five years of poor economic performance, which ultimately translates into unprecedentedly high levels of non-performing loans.

“Banks are still in the process of trying to deleverage for regulatory reasons, which is made harder by the prolonged period of slow growth. While larger banks have benefitted from policy interventions, smaller and regional banks are still finding access to credit both difficult and expensive. As a result, the outlook for new lending to consumers and many corporates in 2013 is pretty dire.”

Forecast for lending to business shows that the north-south divide is entrenched

Banks are just two-thirds through the process of deleveraging, with €132b of further loan book shrinkage expected in 2013. Average loan to deposit levels will have fallen from a pre-crisis peak of 124% in 2006 to an estimated 111% at the end of 2012, and this process has further to go, with the ratio likely to fall to 104% in 2016. As a consequence loan books remain under pressure.

After significant decreases in 2011 and 2012, consumer credit is forecast to decrease again slightly across the Eurozone by 1.2%, while the Consumer Price Index is expected to increase by 1.9%. However, consumer lending is expected to pick up in 2014, when it is forecast to increase by 1.5% as the economy returns to slow growth.

Marie Diron, Senior Economic Adviser to EEFSF says:

“The price of goods and services across the Eurozone has been steadily rising while lending to consumers has shrunk for two consecutive years, hitting households hard. However, the consumer squeeze should start to ease later this year.

“The outlook for lending to businesses paints a more complicated picture, and indicates that the divide in fortunes for the northern and southern Eurozone nations is now becoming entrenched.”

The outlook for lending to business in 2013 shows lending is to increase in France, Germany and the Netherlands by 1-2.5% and decrease in Italy by 0.5% and Spain by 4%. However, when comparing the figures over a two-year period (2011 figures against the outlook for 2013) shows that the north-south divide is becoming entrenched.

Lending in France, Germany and the Netherlands has increased by €18b, €72b and €28b respectively over two years, whereas lending in Italy will have fallen by €43b and in Spain by €100b over the same time period.

Marie adds:

“The cumulative effect of a lack of funding for business in the southern economies will exacerbate and prolong the recession in these countries. Growth in some markets is not foreseen until 2015 at the earliest as a result.”

Insurance profits are expected to have fallen by 5% in 2012

Poor investment returns, combined with business growth being hampered by the recession means that profit for insurers is expected to be down again in 2012. The forecast is for profits to fall by 5%, a cumulative fall of 12% over two years.

Andy says:

“Insurers cannot rely on investment returns in the short-term. The forecast is for interest rates to be pegged at c. 0.75% until at least 2017, and the Eurozone is forecast to face a “lost decade” of low growth. Many insurers will have little choice but to consolidate.”

Unemployment is forecast to peak later this year at 20m and life insurance premiums will suffer when pension contributions fall as a result. The Italian life insurance market has been hit the hardest, with a 25% drop in premiums over the past two years. A further fall of 4% is expected in 2013 as Italian households continue to see their real incomes eroded.

The non-life market will continue to be impacted by the fall in consumer-trigger events as consumers reduce their spending – for example car registrations are expected to be down 5% this year, totaling a 15% decline over two years. As a result, non-life premium growth is forecast to sit at under 2% for next two years, which is substantially below the historic average of 6.2%.

AUM growth is better than expected, increasing by 9.6% in 2012

AUM are forecast to have grown by 9.6% in 2012, more than recovering the losses of 6.9% in 2011, and are set to grow another 6.5% in 2013. This growth is as a result of a better than expected year end for risk assets, but it is also closely pegged to optimism about the Eurozone surviving intact.

Infrastructure investment to rise as long-term investors seek hedge for inflation

On average pension funds have 3.3% of their assets invested in infrastructure but this is forecast to rise to at least 5% by 2016.

Marie says:

“Investors are looking for predictable returns over the long-term; they are looking to hedge against inflation in a low-interest-rate environment and are increasingly looking to diversify their portfolios. There are few asset classes that meet these criteria and we expect investment in infrastructure to grow until investors are less wary of equities.”

Read more: Ernst & Young Eurozone Financial Services Forecast (EEFSF)

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