Austrian banking sector reports another increase in profits amid favorable interest rate environment

Presentation of the 46th Financial Stability Report of the Oesterreichische Nationalbank (OeNB)

Austria is heading for a mild recession in 2023 as economic conditions worsen due to a steady decline in purchasing power. While higher lending rates meant higher financing costs for households and businesses, they also meant wider interest margins for banks. Although Austrian banks posted EUR 7.3 billion in profits for the first half of 2023, risks to the Austrian banking sector and to financial stability have gone up. Following the rapid rise in interest rates, loan growth is slowing down and credit quality is likely to come under pressure, albeit with a lag.

Loss of purchasing power causes decline in economic output

The Austrian economy is moving toward a mild recession in 2023. As the pandemic came to an end, demand shifted from consumer durables to services and the unwinding of global supply chain shortages prompted the reduction of high precautionary inventories worldwide. These conditions particularly weigh on output dynamics in industry, construction and retail trade. Although inventory levels continue to be elevated, energy supply disruptions remain the largest downward risk to the Austrian economy. Such disruptions may occur if the war in Ukraine intensifies or the conflict in the Middle East begins to spread.

Banking sector posts profit in favorable interest rate environment despite slowing loan demand

Austrian banks’ profitability increased further as rising interest rates boosted interest margins while the economic slowdown has not yet impacted credit quality. Moreover, banks have become more cost efficient and generated a profit of EUR 2.7 billion in Central, Eastern and Southeastern Europe (CESEE) in the first half of 2023. Total profits more than doubled year on year, coming to EUR 7.3 billion. On the back of retained earnings, the Austrian banking sector’s common equity tier 1 (CET1) ratio came in at 16.6%, helping the sector to prove resilient also in the OeNB’s recent stress test. However, Austria’s large banks still lag behind their domestic and European competitors. The ongoing gradual increase of macroprudential capital buffer requirements is thus a major step in the right direction.

The significant rise in lending rates did not just drive up bank profitability, however. It also caused loan demand to slow down. In September 2023, the annual growth rate of corporate loans came to 4.4%, less than half the pace recorded at the end of 2022. At the same time, lending to households contracted by 1.4%, driven by negative developments in mortgage lending. From a long-term perspective, these lending dynamics, which follow a current European trend, may reflect some normalization after years of very strong lending.

Lending standards for residential real estate loans have improved considerably; Austrian supervisors increasingly focus on variable rate loans

Since borrower-based measures were made legally binding in Austria in the summer of 2022, lending standards for residential real estate loans have improved significantly and the share of sustainable lending has increased. This seems all the more important as a recent evaluation of the measures found that systemic risks arising from residential real estate financing remain at elevated levels in an environment of increased interest rates, higher costs of living and economic uncertainty. At the same time, the regulation also grants sufficient flexibility by allowing for exemption buckets of 20% of new lending – a high share by international standards. In the first half of 2023, many banks left these buckets largely unused, with half of Austrian banks making use of less than half of the possible exemptions and the volume unused totaling EUR 650 million. From a systemic perspective, variable rate loans also remain a focus of Austrian supervisors. Households’ demand for these loans has rebounded and is strong at present although related interest rate risks for borrowers began to materialize in the course of last year, creating an additional burden in times that are already challenging.

The OeNB’s recommendations for strengthening financial stability in Austria

“The profitability of the Austrian banking sector in the first half of 2023 must be seen against the backdrop of a subdued economic environment. The positive effects of interest rate hikes immediately boost banks’ income, while loan defaults tend to occur with a lag. Their healthy performance helps Austrian banks to build up capital, which further strengthens banking sector stability and creates room for future lending even in difficult economic times,” said OeNB Vice Governor Gottfried Haber. Manifold challenges arise from the still high level of inflation and the resulting tight monetary policy as well as from geopolitical tensions in Ukraine and the Middle East. In this environment, it is likely that Austrian banks’ net interest margin will contract again and credit risks will rise. For Austrian banks to be able to cope with future risks in an uncertain environment, the OeNB recommends that they

• continue to strengthen their capital base, inter alia by exercising restraint regarding profit distributions;
• adhere to sustainable lending standards for residential and commercial real estate financing;
• adequately manage credit and interest rate risks;
• be proactive, in particular, in provisioning for commercial real estate loans and use conservative collateral valuations in this segment; and
• maintain cost efficiency improvements to ensure sustainable profitability.

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.