As the ongoing impacts of rising costs roll into 2023, banks are facing a number of challenges. Increased risks, heightened energy costs and a slowing economy are affecting debtors’ capacity to service their loans, with notable impacts in loan quality across numerous sectors.

In recent months, The European Banking Authority (EBA), the European Central Bank (ECB) and the Bank of England have raised concerns over potential vulnerabilities in residential real estate (RRE) lending, with decreases in demand and prolonged financial worsening serving to increase risk further. 

The following statistics underscore the widespread nature of the economic downturn:

• Stage 2 underperforming loans increased to 9.5% across Europe in 2022
• The value of UK gross mortgage advances in Q3 of 2022 was £85.9 billion – 17.0% higher than in 2021 Q3.
• Eurozone food price inflation in December 2022 saw a significant increase in the prices of sugar, milk cheese and eggs, oils, and fats, with surges of up to 50% in Hungary.

NPLs in Europe: risk-aversion in an uncertain market 

While measures to drive down legacy lending exposures have resulted in NPL ratios reducing across Europe in the last 12 months, regulators have expressed concerns about the impacts of high inflation on small and medium-size enterprises (SMEs) and households. KPMG notes the 9.5% rise of stage 2 loans in 2022 as a potential indicator of asset quality deterioration in the coming year. 

As a result, the ECB has outlined the need for caution and vigilance, signalling calls for EU regulators to pressure banks into implementing better account assessments ahead of time. Resultantly, banks are now seeking to identify signs of borrower distress and outline at-risk customers earlier in the debt journey.

Additionally, major banks have safeguarded their positions through liquidity barriers, with rising interest rates offering protection against declines in asset quality and cost-of-living pressures. 

Macroeconomic factors 

Despite the mitigation efforts, the long-term effects of the financial crisis and continued Ukraine-Russia conflict cannot be easily preempted. For this reason, both established financial institutions and digital lenders are being prompted to operate with strategic astuteness and flexibility. Both groups of organisations are therefore seeking to leverage predictive modelling techniques to better understand borrowing trends and implement safeguarding measures amidst market uncertainty. 

As covid-induced government lending initiatives are shut off and energy prices continue to mount pressure on businesses and consumers, a rise in NPLs appears likely.

The wider economic impacts of the Ukraine-Russia conflict 

An inevitable consequence of the rising fuel costs and lower real incomes from high inflation is a cost for both businesses and consumers. Drastic changes in oil availability and price have led to disruptions and sharp cost increases across all sectors.

Despite the ongoing sanctions against Russia, the nation remains a key energy producer across global markets, facilitating 17% of gas and 12% of global oil production in 2019, directly affecting the price at which many major economies purchase domestic and foreign supplies of oil. Pivotally, these prices have increased significantly since the invasion and subsequent sanctioning. 

To compound matters, both Ukraine and Russia are major agricultural exporters, supplying vast quantities of grains and wheat and accounting for 80% of the world’s supply of sunflower oil. Disturbances in the availability of their agricultural exports have vastly affected food prices and disrupted the availability of essentials like bread and milk across multiple regions.

A response to increased risk

As outlined, banks are being placed under increased pressure to ensure they’re applying comprehensive risk management strategies. Accordingly, the ECB’s latest economic bulletin highlighted the projected global real GDP growth rate (excluding the Eurozone) to slow to 2.6% in 2023. This will likely lead to credit standards and loan supplies tightening, to prevent mounting risk, adding further strain on financially insecure borrowers. 

Steps to safeguarding financially vulnerable relationships 

Though many established financial institutions have implemented protective measures to prevent market risk, the need for a robust method of analysing borrower behaviour and leveraging data remains widespread.

In many cases, transitioning from legacy collections tools to cloud-native solutions serves as the first step in better management of at-risk accounts. By leveraging the use of AI and machine learning to segment customer groups and tailor communications approaches, insightful, actionable data can be gathered, better informing lending approaches, yielding increased recovery rates and improving the customer experience.

Looking for more market insights? Read our blog What the Collections Industry Can Learn From Neobanks