Here, in a companion report to "As The Political Fog Shifts To The U.K., Prospects Are Improving In The Rest Of EMEA," our latest credit conditions report also published on Oct. 2, 2017, we explore sector credit conditions and emerging risks for financial institutions, corporates, insurance, public finance and structured finance in Europe, the Middle East, and Africa (EMEA).
A stronger economic recovery than previously expected; a clearer postelection political landscape in France, Germany, and The Netherlands; and rising consumer confidence should support European banks on their path toward normalization. Lending growth may accelerate, and we could also see consolidation moves, which so far have been scarce and largely domestic, gaining further backing. Rescued banks, particularly those well advanced in their restructuring, are also likely to gradually return to private hands. Indeed, we already saw the Irish government divesting a 29% interest in Allied Irish Banks PLC and the Dutch government divesting an additional 7% interest in ABN AMRO Bank N.V. in June this year.
Banks have generally strengthened capital to the point where they are now considering more generous payouts to shareholders, albeit typically well below those of U.S. banks. Improving profitability to more adequate levels, however, remains a multiyear task.
Unlike in the U.S., where meaningful changes to the orderly liquidation authority framework are under discussion, in Europe resolution frameworks are likely to be enhanced, gaining credibility and effectiveness over time. Indeed, we continue seeing steps toward the creation of a broader and more harmonized market of senior subordinated (Tier III) instruments in Europe, which would facilitate banks' build-up of MREL (minimum requirement for own funds and eligible liabilities) cushions in a more cost-efficient way. While European-wide legislation is still to be discussed and approved by the European Parliament, some countries, in particular Spain and Belgium, have already followed the French initiative and passed legislative reforms to incorporate senior nonpreferred debt as a new debt class in the hierarchy of banks' liabilities. Banks in both countries (Banco Bilbao Vizcaya Argentaria S.A., CaixaBank S.A. and Belfius Bank SA/NV) tapped the market for the first time shortly thereafter.
The announcement early this month of pan-Nordic Nordea Bank AB's decision to relocate its headquarters to Finland (from Sweden) is the first of this kind. While we do not necessarily see others following, we believe the move is indicative of not only Nordea's but generally banks' desire to operate on a level playing field. This remains a priority for policymakers too, not least as they continue their push to complete the EU's banking union. Interestingly too, the Nordea process and outcome have led Danish and Swedish authorities to discuss whether they would be better off inside the banking union.
IFRS 9 To Increase Provisioning From January 2018
IFRS 9, the International Financial Reporting Standard that includes requirements for recognition and measurement, impairment, and general hedge accounting, comes into force from Jan. 1, 2018, but there is still limited disclosure from banks (in Europe and elsewhere) about the quantitative impact on their financials. It may not be until early 2018, at the time of banks' publication of their 2017 annual reports, before we start to see such information disclosed.
One of the purposes of IFRS 9 is the earlier recognition of expected credit losses in banks' financial reporting, through a requirement for both a 12-month expected loss provision on all performing loans and a lifetime expected loss provision on underperforming and nonperforming loans. There will thus be a hit to equity as opening balance sheets are restated and higher provisioning requirements become effective on day one, but given a broadly benign asset quality backdrop, we expect the impact to be manageable for most European banks.
There will also likely be greater volatility in provisioning charges. The regulatory capital impact of IFRS 9 should be limited in the EU, as plans are underway to set up transitional arrangements to phase in the impact to CET1 (common equity tier 1) over five years. Banks could still opt to fully load the impact of IFRS 9 on regulatory capital, but that would mean placing the bank in a comparatively weaker position ahead of future stress test exercises.
At present we do not expect the implementation of IFRS 9 to affect bank ratings in EMEA, as changes in accounting rules by themselves do not denote an altered situation, just affect the way a situation is reported. Only in the event application of IFRS 9 reveals fragilities not previously considered could ratings be affected.
Over time, IFRS 9 could also affect banks' commercial behavior. There may be a shift toward shorter-duration loan products, or a move toward higher pricing on certain products such as corporate loans and mortgages.