Credit risks increase for the first time after years of decline – Austrian banks use profits to shore up risk buffers

Presentation of the 47^th Financial Stability Report of the Oesterreichische Nationalbank (OeNB)

The Austrian economy was in recession in 2023. The Oesterreichische Nationalbank (OeNB) expects the economy to stabilize in 2024 but to grow only at a modest pace. Despite this economic environment, Austrian banks achieved record profits in 2023, which they used to further bolster their capitalization. As a result, the risks to financial stability arising from the banking sector continued to recede. Still, the domestic banking sector is now at a turning point, as it faces heightened geopolitical and increasing credit risks, particularly in the commercial real estate sector, and interest rates were recently cut for the first time after a hiking cycle.

Declining inflation drives economic recovery

The Austrian economy was in recession in 2023. This was due to a combination of persistently high inflation, a very weak external environment, and the resulting poor overall sentiment. The OeNB expects the economy to stabilize in 2024, but growth is forecast to be a modest 0.3%. Private consumption is recovering on the back of significantly higher real wages, and exports will also make a positive contribution to economic growth. Gross fixed capital formation, by contrast, will continue to shrink in 2024. High financing costs and a poor earnings outlook are weighing particularly on investments in residential construction and in plant and equipment.

Banking sector achieves record profit despite increasing loan defaults

Austrian banks reported a record EUR 14 billion in profits in 2023 – despite a persistently weak macroeconomic environment. The increase in profits was mainly due to a further rise in the net interest margin. As monetary policy was tightened, interest rate hikes led to higher income. Thanks to its substantial profits, the banking sector’s consolidated common equity tier 1 ratio increased significantly, to 17.5%. Moreover, the capitalization of Austria’s largest banks surpassed the average of their European peers for the first time. “Banks have used their profits to strengthen their resilience to future uncertainties. What applies to the banking system as a whole does not necessarily hold true for each individual bank, however. There is a need, therefore, to address bank-specific risks at the single bank level in a targeted manner,” said the OeNB’s Vice Governor Gottfried Haber.

In fact, the banking system has reached a turning point: Apart from the uncertainties resulting from geopolitical risks, several factors are putting increased pressure on its profitability. The rising number of insolvencies observed at the end of 2023 has already led to an increase in loan defaults, and this trend continued into 2024. Besides, the cost side has come into focus: Depositors have shifted their savings from sight to term deposits, which drives up banks’ funding costs. Plus, in light of inflation-related increases in wages and material costs, banks will have to steadily maintain cost discipline, not least to make room for necessary investments in new information technologies.

In addition, higher interest rates have reduced the demand for loans. This is particularly the case for residential real estate financing, whose  systemic risks were effectively addressed by borrower-based measures. The latter have significantly improved the sustainability of lending standards, which will continue to be a key pillar of financial stability. Banks left a large part of the measures’ exemptions unused. This indicates that the decline in the lending volume was primarily driven by higher interest rates, high construction costs and general uncertainty over the economic environment. The same factors have also driven up defaults of commercial real estate (CRE) loans. In addition, adjustments to CRE valuations do not yet, across the board, reflect the new, challenging environment.

The OeNB’s recommendations for strengthening financial stability in Austria

Persistently weak economic growth in Austria and prolonged geopolitical conflicts continue to pose major challenges. In light of the interest rate cut in early June, the interest margin of the banking sector is not expected to increase any further. Also, increased credit risks will likewise put pressure on banks’ profitability. For Austrian banks to meet the challenges ahead, the OeNB recommends that banks:

• continue to safeguard and, where necessary, further strengthen the capital position by exercising restraint regarding profit distributions (dividend payments and share buybacks);
• adhere to sustainable lending standards for real estate loans and prepare for higher risk weights for commercial real estate loans;
• ensure adequate credit and interest rate risk management practices, including higher provisioning and conservative collateral valuations; and
• ensure sustainable profitability by maintaining cost discipline and by investing in new information technologies as well as in protection against cyber risks and the impact of 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.