Increased financial stability risks require banks to exercise prudence on profit distributions

Presentation of the 44^th Financial Stability Report of the Oesterreichische Nationalbank (OeNB)

The risks to financial stability have increased markedly since the beginning of the year. Higher interest rates on loans and rising inflation have put pressure on households and businesses. As a result, housing loan growth has slowed down recently. The new regulation on sustainable lending standards for residential real estate financing, which turned existing criteria into legally binding requirements, had become necessary to address systemic risks relating to a deterioration in loan quality. Despite the challenging environment, Austrian banks posted high profits in the first half of 2022. Still, banks are advised to follow a prudent approach to profit distribution in order to brace themselves for the heightened economic and geopolitical risks.

The Eurosystem’s monetary tightening is driving up interest rates for borrowers

The Austrian economy is losing some momentum after having grown at a robust pace in the first half of 2022. Uncertainties associated with the war in Ukraine and high inflation have a dampening effect on growth. In order to stem price growth, the ECB adopted further tightening measures in its latest decision. “The tightening of monetary policy has already translated into higher interest rates for borrowers in Austria,” OeNB Governor Robert Holzmann said at the press conference presenting the OeNB’s Financial Stability Report 44. But despite increasing interest rates for borrowers, companies’ demand for bank loans is still high, as supply chain disruptions caused by the war in Ukraine as well as recent price hikes are adding to Austrian companies’ liquidity needs. The corporate sector’s debt ratio went up somewhat recently but is still well below the euro area average. According to most recent insolvency data, the number of companies unable to meet their payment obligations remains stable.

Households with variable rate loans faced with increasing debt-servicing costs

The annual growth of bank loans to households, especially housing loans, has lost some momentum recently, but, at 4.7% in September, it is still at a high level, higher than throughout the years 2008 to 2020. At the same time, households’ indebtedness relative to their disposable incomes is not trending up (in the aggregate across households with and without debt) despite high loan growth. That said, the current environment of high inflation and rising interest rates on loans limits borrowers’ financial room for maneuver. Around half of all new loans taken out over the past five years carry variable interest rates, which means that many indebted households are now faced with sharply rising debt-servicing costs. In addition, household expenditure is also rising because of high inflation. As a result, the share of households that may run into repayment difficulties is going up.

New regulation on sustainable lending standards for real estate financing in Austria reduces risks

The systemic risks associated with residential real estate financing have been increasing continuously for the past few years, mainly due to rising prices, the growing indebtedness of borrowers, the high share of variable rate loans originally extended at low interest rates as well as banks’ inadequate compliance with the previous recommendation on sustainable lending standards for residential real estate financing. In Austria, these developments have been more pronounced than in other European countries. A number of international organizations, including the IMF, the OECD, the ECB and the European Systemic Risk Board (ESRB), therefore advised Austria to implement borrower-based measures. The majority of EU member states already have such measures in place, which are considered international good practice. Given that banks had not sufficiently acted on the Austrian Financial Market Stability Board’s recommendations issued in 2016 and 2018 amid a highly competitive environment, the Austrian Financial Market Authority (FMA) adopted a legally binding regulation with effect from August 2022. The newly adopted regulation contributes to safeguarding financial stability by curbing excessive developments in residential real estate lending, e.g. disproportionately high loan growth, insufficient collateral, insufficient borrower own funds as well as excessive debt-servicing costs and maturities. Now that interest rates and the cost of living are rising rapidly and real estate prices are very high, this is particularly important, not only for reasons of financial stability but also to prevent households’ overindebtedness. It is therefore in the interest of both banks and borrowers that affordable home purchases remain fundable, while unsustainable household debt does not serve as an alternative to affordable housing.

Retained earnings to enhance banking sector resilience

The results of the latest OeNB stress test show that the Austrian banking sector’s risk-bearing capacity is sound. In the course of 2022, however, the adverse effects of inflation and persistent geopolitical tensions have increased financial stability risks. This notwithstanding, Austrian banks posted profits of EUR 3.8 billion in the first half of 2022, benefiting from rising interest rates, high loan demand and positive one-off effects. Given the ESRB’s general risk warning for the EU financial system, Austrian banks should use their currently high profits to strengthen their capital base even further. As OeNB Vice Governor Gottfried Haber explained, “It is crucial that the rating of the Austrian banking sector, which is excellent also by international standards, be protected and maintained. This ensures low refinancing costs for banks, which benefit not only the finance sector but, eventually, the whole economy.” In this context, the planned increase in macroprudential capital buffers will also help strengthen the Austrian banking sector’s resilience and reputation further.

The OeNB’s recommendations for strengthening financial stability in Austria

To ensure that the Austrian banking sector is well equipped for navigating the increased risks, the OeNB recommends that banks

• strengthen the capital base in a sustainable and forward-looking manner, especially by exercising restraint with regard to profit distributions;
• adhere to sustainable lending standards for residential and commercial real estate financing;
• ensure that credit and interest rate risk management practices adequately reflect changes in the risk environment, especially considering the past long period of low risks;
• continue efforts to improve cost efficiency in order to ensure sustainable profits; and
• further develop and implement strategies to deal with the challenges of new information technologies, cyber risks and climate change.

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