Austrian banking sector continues to fully perform its function during the COVID-19 pandemic, but increasing insolvencies are set to weigh on loan quality

Presentation of the 40^th Financial Stability Report of the OeNB

The measures to contain the COVID-19 pandemic have led to the deepest slump the Austrian economy has experienced in many decades. Support measures taken by the government, the central bank and supervisory authorities have so far focused, inter alia, on maintaining businesses’ liquidity by keeping up the supply of bank credit. This, however, will increase corporate indebtedness in the longer run. That said, the Austrian financial sector is currently in a robust state, and this is one of the reasons why – from today’s point of view – it can be expected to effectively cope with the risks to financial stability once the support measures expire. Still, the quality of banks’ loan portfolios is bound to worsen markedly given the increase in insolvencies anticipated for 2021. Banks have therefore already started to step up risk provisioning, which was reflected in a significant profit slump in the first half of 2020.

After major price declines immediately after the outbreak of the COVID-19 pandemic, international financial markets have stabilized on the back of decisive monetary and economic policy action. “Both euro area sovereign bond yields and risk premiums on sovereign and corporate bonds have returned to pre-pandemic levels. The stabilization in financial markets improved financing conditions for companies, households and governments,” Governor Robert Holzmann said at the presentation of the 40^th issue of the OeNB’s Financial Stability Report.

The measures taken to contain the COVID-19 pandemic led to a massive slump in economic activity in Austria in the first half of 2020. After a strong recovery in the third quarter, the economic catch-up process started to stall. The second lockdown imposed in November is expected to cause a renewed slump, if a less severe one than in spring 2020. A great number of businesses suffered sudden drops in sales, which gave rise to a sharp increase in demand for liquidity. In this environment, it became a key priority to maintain companies’ liquidity. An essential instrument in this respect was keeping up the supply of bank loans. Fiscal, monetary policy and supervisory support measures have, inter alia, helped safeguard the supply of credit to the corporate sector. As a result, loan growth in Austria has remained at levels comparable to those seen before COVID-19. In the current situation, loans are primarily taken out to maintain business operations, while investment funding has become less important.

The comprehensive set of support measures has cushioned the impact of the COVID-19 pandemic on the real economy. The number of corporate insolvencies even decreased in the second and third quarters of 2020, which, however, was also due to the suspension of the obligation to file for insolvency in the case of overindebtedness. Still, borrowing will push up corporate debt levels, while declining profits will reduce the funds for debt servicing and building up equity. A model developed by the OeNB to estimate the number of expected corporate insolvencies shows that the comprehensive support measures are reducing the number of insolvencies by around two-thirds in 2020.

The Austrian banking sector continues to fully perform its economic function during the ongoing COVID-19 pandemic. The take-up of loan moratoria, which was strong especially at the beginning of the pandemic, has been decreasing markedly in Austria more recently. As the number of corporate insolvencies is expected to increase despite the large-scale support measures, banks will face a palpable rise in their credit risk costs. Yet, given that at the onset of the pandemic, banks’ capital and liquidity positions were much better than during the great financial crisis, the sector is currently expected to efficiently cope with the risks associated with the expiry of the support measures. “Austrian banks have started to step up risk provisioning already in the first half of 2020 to be braced for future challenges resulting from the COVID-19 pandemic,” Vice Governor Gottfried Haber explained. The year-on-year slump in the banking sector’s half-year profit reflected this increase in provisions. Similar – albeit less pronounced – trends have been observed for Austrian banks’ subsidiaries in Central, Eastern and Southeastern Europe (CESEE).

Austrian banks managed to keep their capital ratios stable in the first half of 2020, not least thanks to temporary regulatory easing at the European level. Moreover, current stress test results confirm that the domestic banking sector’s risk-bearing capacity is adequate. The banks are sufficiently capitalized to continue to supply the real economy with loans. In the face of big challenges, the Austrian banking system continues to do well compared to the European average – an assessment also shared by international rating agencies. Nonperforming loans have been reduced significantly over the past few years, and profitability is above the European level despite the sharp drop in profits. In order to protect their profitability in the medium term, banks have implemented efficiency-enhancing measures, including, for instance, a significant reduction of the number of branches in Austria over recent years. At the same time, the availability of banks has remained good for the majority of the population, as a study in this issue of the Financial Stability Report shows.

On top of the challenges associated with the ongoing low interest rate environment, Austrian banks’ profitability has come under additional pressure through higher loan loss provisioning. More than half a year into the COVID-19 pandemic, legislative and voluntary measures are seen to be strongly supporting the real economy and, indirectly, the banking sector. At the same time, some of these measures make it more difficult for banks, investors and, eventually, supervisors to assess risks. Furthermore, the slowdown in economic activity and increased corporate indebtedness entail higher risks to financial stability. In this challenging environment and with a view to strengthening financial stability, the OeNB recommends that banks take the following measures:

• In view of a further rise in credit risks and heightened uncertainty: focus on a solid capital base, i.e. avoid share buybacks and carefully consider profit distributions in accordance with European recommendations.
• Prepare for the time when payment moratoria and government guarantees for loans expire and ensure transparency regarding the quality of loan portfolios.
• Apply sustainable lending standards, in particular in real estate lending, and comply with the quantitative guidance issued by the Financial Market Stability Board.
• Continue efforts to improve operating efficiency in order to ensure sustainable profitability, even under the currently challenging circumstances.
• Develop and implement strategies to deal with the challenges of new information technologies.

The OeNB’s semiannual Financial Stability Report provides analyses of Austrian and international developments with an impact on financial stability and includes studies offering in-depth insights into specific topics related to financial stability.