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Lower And Later: The Shifting Horizon For Bank Credit Losses

The COVID-19 pandemic and responses to it will have large and long-lasting effects on bank asset quality. Across the 88 banking systems S&P Global Ratings covers, we expect that final 2020 data will show credit losses of around $890 billion (see chart 1). This is around a third lower than our previous forecast in July 2020 (see The $2 Trillion Question: What's On The Horizon For Bank Credit Losses, published July 9, 2020), though still almost two-thirds higher than losses recorded in 2019.

Chart 1


As well as somewhat lower credit losses in aggregate, our revised forecasts also reflect a shift in the timing of these losses--we now expect them to be spread more evenly across our forecast period (see chart 2). This change reflects the ongoing pandemic as well as ongoing debt moratoria and fiscal support in many cases.

We expect that final 2020 data will show credit losses of close to $900 billion, a third lower than our previous forecast. And we now forecast a similar level of credit losses in 2021, at around $910 billion--a rise of 10% from our previous forecast. For 2022, we forecast credit losses will decrease slightly to around $870 billion, still well above recent pre-pandemic levels. Indeed, we expect that 2019 marked the end of a multiyear period of benign credit losses for banks globally, even as economies continue to recover from the pandemic.

Chart 2


We use the term credit losses to refer to the income statement charge (in U.S. dollars) by which banks add to their balance sheet provisions or allowances for expected losses on domestic customer loans, plus any direct write-offs of domestic customer loans. Banks often describe credit losses as "provisions for" or "charges for expected credit losses," among other similar terms. Credit losses generally precede charge-offs, the actual write-down of loans that detract from the balance sheet allowances for credit losses. The cost of risk (or credit cost ratio) refers to credit losses as a proportion of customer loans.

Our forecasts are based on our analysts' estimates for nonperforming loans (NPLs) and related provisioning. Regulatory forbearance, jurisdiction-specific rules, or bank management decisions regarding slowing the pace of loss recognition, will affect the timing and recognition of credit losses in banks' financial reporting. In our view, and as the aftermath of the 2008-2009 financial crisis showed, delays in the recognition of credit losses by banks, or a lack of transparency in reporting such losses, could undermine investor confidence in banks and may delay the path to recovery for some countries.

As vaccine rollouts in several countries continue, S&P Global Ratings believes there remains a high degree of uncertainty about the evolution of the coronavirus pandemic and its economic effects. Widespread immunization, which certain countries might achieve by midyear, will help pave the way for a return to more normal levels of social and economic activity. We use this assumption about vaccine timing in assessing the economic and credit implications associated with the pandemic (see our research here: As the situation evolves, we will update our assumptions and estimates accordingly.

Yearly Global Credit Losses To Increase By Over 60% In 2020-2022, With Large Regional Differences

We expect that on a global scale, bank credit cost ratios will be just above 100 basis points (bps) in 2020 and 2021, before falling back a little to around 90 bps in 2022. These ratios are well above their 2019 level of 72 bps (see chart 3). We estimate this ratio was around 100 bps to 120 bps in the aftermath of the 2008-2009 global financial crisis (GFC). That said, we note that a comparison with credit losses in the GFC is not a like-for-like assessment. This is because of factors such as current accounting rules that require a more timely recognition of credit losses than rules in place during the financial crisis, as well as the composition of global lending now being more weighted toward developing-market economies (including China) that tend to have weaker asset quality. We also note that the global financial crisis had a more limited effect on loan asset quality in some regions (including Asia-Pacific, for example) than we expect to be the case now.

Chart 3


Our projections for credit losses vary widely among regions, in size and timing of their recognition (see charts 3 and 4). Globally, we expect the total increase in credit losses will amount to $1 trillion over three years to end-2022, from the 2019 level. (By increase, we mean the sum of the differences in projected credit losses for each of 2020, 2021, and 2022 compared to actual credit losses for 2019.)

Of this total increase, Asia-Pacific accounts for over half, dominated by an increase of $453 billion in China. This largely reflects the sheer size of the Chinese banking system in a global context (see charts 5 and 6) and stringent regulatory provision coverage requirements over nonperforming loans. In terms of customer loans, the Chinese banking system is approximately the same size as the U.S., Japanese, German, and U.K. banking systems combined. Moreover, the banking system in China is relatively much more important in the supply of credit to its economy than the U.S., where borrowers can typically benefit from a deep, liquid, and mature bond market, a large nonbank financial institution sector, as well as access to funding via the banking system. Western Europe accounts for a further $183 billion of the increase, followed by $148 billion in North America.

These differences and changes can arise for myriad reasons. China was first hit by the outbreak, but this quickly came under control; further, China was the only major economy to register positive GDP growth in 2020. We expect Chinese banks will extend debt moratoriums, spreading out credit costs over several years. As default rates rise, including state-owned enterprises, we also anticipate high new formation rates of NPLs, a rising credit cost, and write-offs that exceed the pace of loan growth over the next two to three years (see China GDP Recovery, Moratoriums, And Write-Offs Keep Banks' Bad Loans In Check, published Feb. 2, 2021).

Chart 4


From a credit analysis perspective in the context of the pandemic, governments' actions to support their citizens (fiscal measures), regulatory actions to support borrowers (forbearance measures), and banks' disclosures (financial reporting norms) are all important elements in informing our assessments of bank asset quality. Another factor that influences differences in expected loss levels and their timing is the relative split of bank lending by sector among banking systems, with certain unsecured or corporate lending activities, for instance, likely to be more exposed to sharp spikes in provisioning than mortgage and other secured loans.

For each of these factors, the impact can differ among banks and banking systems. For example, social support programs in many Western European countries--in terms of employment protection and welfare benefits (in particular for unemployment or illness) tend to be a relatively more supportive factor for asset quality than in some other countries.

Major Banks Are Relatively Well Positioned To Absorb Credit Losses From Earnings

We estimate that the top 200 rated banks represent about two-thirds of global bank lending. For these banks, we estimate that credit losses will absorb about half of their 2020 pre-provision earnings, and around 45% in 2021 and 2022. By way of comparison, in 2019 the ratio was just around 30%. We expect earnings of the top 200 rated banks to recover in 2021 and 2022, fueled by strong lending dynamics, particularly in China, where we expect lending growth of over 10% per year over this period (see charts 5 and 6).

Chart 5


Chart 6


Still, the pandemic is not over yet, and of course the risk that the path to recovery proves to be worse or takes longer than we assume in our base-case looms on the horizon (see table 1). Such setbacks would likely lead to higher credit losses (as more borrowers become distressed), as well as lower pre-provision earnings (from reduced economic activity and potentially lower interest rates)--a combination that would inevitably affect many banks across the world. Moreover, even if the spread of the virus were to end tomorrow, the effects could linger, especially if social distancing becomes the norm or business and consumer spending doesn't bounce back as people remain cautious in the face of potential uncertainty.

Table 1

GDP Growth And Recovery Forecasts
Real GDP growth rates Recovery to end-2019 level
(%) 2019 2020f 2021f 2022f 2023f GDP Unemployment
U.S. 2.2 (3.9) 4.2 3.0 2.1 Q3 2021 >2023
Eurozone 1.3 (7.2) 4.8 3.9 2.2 Q2 2022 Q4 2023
China* 6.1 2.3 7.0 5.0 5.0 Q2 2020 Q4 2020
India¶ 4.2 (7.7) 10.0 6.0 6.2 Q2 2021 N/A
Japan 0.7 (5.5) 2.7 1.3 0.9 Q1 2023 >2023
Russia 1.3 (3.5) 2.9 2.7 2.0 Q4 2021 Q2 2023
Brazil 1.1 (4.7) 3.2 2.6 2.6 Q3 2022 Q1 2023
U.K. 1.3 (11.0) 6.0 5.0 2.4 Q4 2022 >2023
World§ 2.8 (4.0) 5.0 4.0 3.6 N/A N/A
*China's GDP for 2020 is actual, not forecast. ¶Fiscal year ending in March. §Weighted by purchasing power parity. N/A--Not applicable. Source: S&P Global Economics, Oxford Economics

China is the only major region globally where we expect positive GDP growth across the three years to 2022 (see table 1). While we expect the U.S. economy will also rebound strongly in 2021, the contraction in 2020 is significant. Western Europe faces an even deeper contraction in 2020, with a strong though still partial rebound in 2021. The decline in output across all regions may well test rating boundaries for banks as asset quality weakens. In addition, the likely wind-down of government fiscal support and loan forbearance programs (such as short-term repayment moratoriums) may reveal new fragilities in asset quality.

Fiscal Measures Continue To Provide Support To The Economy, But Their Eventual Withdrawal Is Inevitable

The unprecedented level of fiscal support that many governments across the world have deployed in response to the pandemic-related slowdown has been a key factor in supporting their citizens and economies, particularly during lockdown periods. Time will tell whether the size and duration of such support has been effective enough. From a bank credit risk perspective, perhaps the greater danger at this time is the reduction of such support too early, resulting in a longer and deeper economic contraction, further impairing banks' asset quality and increasing credit losses. We do not see evidence of this yet, but even under our base case, the recovery will take time, with lower GDP growth (and higher unemployment) for a number of years. Moreover, the level of fiscal support has varied across the world, and is more modest in some lower income countries.

Borrower Forbearance, Intended To Bridge Short-Term Liquidity Constraints, May End Up Masking Declining Asset Quality

Many banks across the world have introduced payment moratoriums or other forms of borrower forbearance as part of responses to the effects of the pandemic. Whether mandated by authorities or led by the banking industry, the aim of the forbearance is to help stabilize borrowers' creditworthiness--in other words, to prevent borrowers who are facing short-term liquidity shortfalls from becoming insolvent and defaulting on repayments.

Borrower forbearance has been effective in the past, such as after natural disasters. But the extent of the current, pandemic-related, forbearance activity is unprecedented in scale. Broader concerns about social stability and the public confidence effects of pandemic-related actions such as lockdowns may well have played a role in the size of current forbearance programs. Regulators and standard-setters have demonstrated a relatively transparent and flexible approach in the application of accounting and regulatory rules in relation to forbearance activity, encouraging banks to consider the effects of the expected relatively rapid rebound in economies rather than just the near-term economic downturn.

Indeed, forbearance activities are generally intended to be short term--a three- or six-month repayment holiday has been a common forbearance feature in many countries--in the expectation of a relatively rapid economic recovery. As such, forbearance is not necessarily an automatic indication of a decline in asset quality, for now. Even so, we note there have been extensions to original payment holidays in a number of countries, as the end of lockdown periods and the starting path to recovery comes later than initially anticipated. That is why we are mindful of the risk that protracted borrower forbearance activity ends up masking declines in underlying asset quality.

Estimations Of Expected Credit Losses In Banks' Financial Reporting

A key aspect of bank financial reporting that is relatively new--and broadly untested in a downturn--is the estimation of credit losses. Both International Financial Reporting Standards (IFRS, the financial reporting rules applicable across much of the world outside of the U.S.) and U.S. Generally Accepted Accounting Principles (U.S. GAAP) require banks to take a more forward-looking approach when estimating credit losses on their loan portfolios. The new rules took effect in 2018 for banks reporting under IFRS and in 2020 for large banks reporting under U.S. GAAP.

The two sets of rules are markedly different in their approach. In broad terms:

  • The U.S. GAAP model is based on an estimate of current expected credit losses (CECL), which requires banks to set reserves for expected lifetime losses on their entire loan portfolio.
  • The IFRS model, expected credit loss (ECL, as set out in IFRS 9), requires a dual measurement approach under which a 12-month ECL allowance is established for performing loans and a lifetime ECL for underperforming and NPLs.

These rules mean that as banks increase their expectations for future credit losses, they may have to increase reserves markedly. And the difference between the two approaches is likely one reason why U.S. banks' credit losses in the first half of 2020 were markedly higher than some European banks', for example. We are now seeing U.S. banks reduce loan loss reserves (with charge-offs exceeding fairly minimal new provisions for credit losses)in their fourth-quarter earnings, reflecting a combination of better-than-expected borrower performance to date and a more positive economic outlook.

For banks reporting under IFRS, a crucial question is whether loans under forbearance measures are experiencing a significant increase in credit risk since origination, because that is the trigger for the loan moving from a 12-month ECL provisioning requirement to a lifetime ECL. We expect to see increasing stage migration over this year--as economic uncertainty reduces and support mechanisms wind down, the underlying asset quality picture will emerge more clearly.

What's On The Horizon For Bank Credit Losses, By Region

Below, we set out a synopsis of credit loss forecasts for regional banking systems across the world over the three years to end-2022.

Asia-Pacific: Asset quality metrics won't fully recover until 2023

We forecast credit losses of $1.57 trillion from 2020 to 2022 for Asia-Pacific banking systems. Given its size, China accounts for more than one-half of the region's loans and more than three-quarters of these losses. While we expect China's GDP recovery and lenders' deft management of bad assets to improve loan quality metrics, increasing default rates and moratorium extensions are likely to keep credit cost increases at a faster rate than the pace of loan growth over the next two to three years (see China GDP Recovery, Moratoriums, And Write-Offs Keep Banks' Bad Loans In Check, Feb. 2, 2021). India has the highest nonperforming asset (NPA) ratio of the region's major economies, estimated at around 10% in the next 12 months. Its system loans contribute to less than 3% of loans in the Asia-Pacific.

Recoveries to pre-COVID-19 levels will likely be slow and uncertain, as in other regions. We expect that credit metrics for the region's banking systems as a whole may not recover to 2019 levels until 2023. China, South Korea, Singapore, and Hong Kong may be among the first in Asia-Pacific to recover to 2019 financial strength, but not until the end of 2022. Australia, Japan, and Indonesia may be among those to recover next, by year-end 2023. For India and Indonesia, the path to recovery from the pandemic may be more painful. This is because India is seeing a steep recession in 2020 and had high NPLs leading into the pandemic. Indonesia is among the hardest hit countries by the pandemic in Southeast Asia. Regulatory forbearance that allowed restructured loans to be classified as performing until end-March 2022 has mitigated damage to bank financials. However, underlying deterioration in asset quality could become more apparent after this expires.

Asset quality in the region will remain challenged in 2021, noting that underlying profitability (excluding Japan) and capitalization will assist with buffering against asset quality deterioration.

North America: Robust uptick in loan provisions driven by regulatory requirements

We recently reduced our 2020 and 2021 forecasted credit losses for North America to $259 billion from $366 billion, as we have become less pessimistic about the U.S. in particular. Its economy has continued to rebound, a new stimulus bill has been passed, and banks have reported sharp declines in loans on forbearance.

In our base case for the U.S., we now expect the pandemic-related loan loss rate will be about one-third the roughly 6% level the U.S. Federal Reserve projected in its nine-quarter severely adverse scenario (which is unrelated to the pandemic) in its June 2020 stress test. Still, loss rates for banks with high exposures to commercial real estate and challenged commercial sectors could well exceed that.

Through the first three quarters of 2020, U.S. FDIC-insured banks reported a robust $129 billion in provisions for credit losses, pushing the ratio of allowances for credit losses to loans and leases to 2.24% at Sept. 30, 2020, from 1.18% at the end of 2019. We believe U.S. banks provisioned faster than banks in most other regions in the first half of 2020 because of the implementation of the CECL accounting methodology. That has allowed them to slow provisions greatly and should lead to lower provisions in 2021 than in 2020. In fact, banks that have reported fourth quarter earnings have generally shown moderate declines in their allowances as they have become somewhat less pessimistic about the economy and expected charge-offs.

Western Europe: Credit losses will remain elevated as forbearance and fiscal support measures wind down

We estimate that European banks' credit losses peaked in 2020, at around $135 billion, but will decline only moderately this year, to around $123 billion. This reflects the fact that even as the economic recovery gets underway this year, some borrowers will not recover fully as fiscal support measures wind down and debt moratoria expire. We expect losses to fall further in 2022, to around to $88 billion, once these losses crystallize and as European economies continue their path to recovery. This still represents an elevated level of losses compared with actual losses of just $54 billion in 2019.

We see bank transparency about asset quality metrics as a key element for investor confidence in banks. We expect that IFRS 9's reporting requirements will be helpful in this regard, though a lack of comparability across banks will likely remain less than ideal. That said, the European Banking Authority has rapidly mandated standardized disclosure templates for the extent of loans subject to pandemic-related forbearance and new loans granted that carry a government guarantee. These disclosure templates are published twice a year by banks and are intended to end in December 2021.

Latin America: Robust loan loss provisions raised in 2020 will help banks navigate the second wave of infection

We forecast credit losses of $136 billion over the two years to end-2021 for banking systems in Latin America, with the bulk of these from the region's largest economies, Brazil ($72 billion) and Mexico ($22 billion). We expect credit losses for the region to be around $64 billion in 2022; credit metrics may not recover to 2019 levels until after 2022.

A slow vaccine rollout, as well as the implementation of new restrictions (while not as severe as at the onset of the pandemic), means that the recovery in the region will be relatively slow. We expect lending growth to slow this year in Brazil (at about half the rate of 2020) and to pick up only modestly in Mexico. This is primarily due to the absence of extraordinary measures from the government, as well as a lower appetite from banks to take on additional risk in light of uncertainties from the second wave of infection.

That said, we expect major Brazilian banks' credit costs to remain manageable thanks to banks' conservative growth strategies in the past two years and regulatory measures that will help cushion the impact. On the other hand, our estimate of losses for Mexican banks considers their relatively low credit growth prior to the pandemic crisis, low leverage in the economy (as measured by credit to GDP), and relatively high provisioning coverage. For both countries, it is important to note that credit losses in 2020 measured in U.S. dollars are lower than in local currency due to the effect of currency depreciation.

Banks in the region have historically been subject to highly volatile economic and political conditions, and they can quickly adjust to those environments. Still, much depends on the effects of the second wave of infection and vaccine rollout and the effects on the region's economies.

Central And Eastern Europe, Middle East And Africa: Navigating through COVID-19

We forecast credit losses of $162 billion over the two years to end-2021 for banking systems in Central and Eastern Europe (CEE) and the Middle East and Africa (MENA).

In addition to the asset quality deterioration that we expect for banks in developed markets, some banks in emerging markets, including CEE and MENA are also exposed to additional sources of risks including:

  • Heavy reliance on external funding;
  • Concentration of their economies on specific sectors (such as the hospitality sector or industrial or service exports to developed countries) or commodities (such as oil or gas); and
  • Lack of government capacity to provide extraordinary support, weaker governance and efficiency of government institutions, and a higher likelihood of political and social tensions.

For banks in GCC countries, asset quality deterioration is set to continue as regulatory forbearance measures fade over the next 12 months. However, we expect this process to be gradual to minimize the impact on the banking system. With lower interest rates and lending growth, a few banks might show losses in 2020 or 2021 because of their exposure to high-risk asset classes (for example, SMEs or credit cards) or due to under-provisioning.

We think that the UAE, Oman, and Bahrain will take longer to recover. For Oman and Bahrain, this is because of a weaker capacity to support their economies. In the UAE, the simultaneous shocks to several sectors and the federal structure of the country are likely to have a greater impact on asset quality, potentially making their governments more selective in extending support. In Saudi Arabia, we expect the cost of risk to normalize gradually from 2022, despite the negative impact of low rates on profitability. In Qatar, we also foresee a quicker normalization of the cost of risk because of the strong state footprint in the economy and the upcoming 2022 FIFA World Cup in Doha. For Kuwait, we consider that the provisions banks have accumulated over the past few years will help them navigate this challenging time.

In Turkey, public support measures, coupled with forbearance in asset quality classification and massive lending expansion, have allowed NPLs ratio to decline to a very low 3.9% as of November 2020. However, it is only a matter of time before NPLs gradually rise to peak in 2022. SME and real estate exposures will contribute the most to asset quality deterioration. We expect Turkish banks to continue to increase their provisions in 2021. Finally, Turkish banks remain highly dependent on external funding, although their external debt has continued to decline. An unexpected materialization of geopolitical risks or a shift in the country's policy direction could push some investors to look for other, more stable markets.

In Russia, the oil price shock will compound the impact of the COVID-19 pandemic on banks' asset quality and profitability, despite measures implemented by governments to contain the coronavirus. We expect a gradual normalization of credit losses over the next two years on the back of anticipated economic recovery and accommodative monetary policy. However, stabilization of credit losses and rising fee revenue won't be sufficient to offset the loss of net interest income. We don't think the cost of risk will reach the pre-pandemic level of 1.0% until at least 2023, because banks will continue to create provisions for problem assets accumulated during the pandemic, mainly loans to corporate clients (see Russian Banks Face A Tougher Path To Profit, published Jan. 27, 2021).

Related Research

  • Ratings Component Scores For The Top 200 Banks Globally--February 2021, Feb. 2, 2021
  • Banks In Emerging Markets: 15 Countries, Three Main Risks (January 2021 Update), Jan. 19, 2021
  • Questions That Matter: Will Returns Ever Recover? Dec. 3, 2020
  • Global Banks 2021 Outlook: Banks Will Face The Next Test Once Support Wanes, Nov. 17, 2020
  • Global Banks Country-By-Country 2021 Outlook: Toughest Test For Banks Since 2009, Nov. 17, 2020
  • Top 100 Banks: COVID-19 To Trim Capital Levels, Oct. 6, 2020
  • Global Banking: Recovery Will Stretch To 2023 And Beyond, Sept. 23, 2020
  • The $2 Trillion Question: What's On The Horizon For Bank Credit Losses, July 9, 2020
  • China GDP Recovery, Moratoriums, And Write-Offs Keep Banks' Bad Loans In Check, Feb. 2, 2021
  • Japan Banking Outlook 2021: Expect Rising Credit Risks, Jan. 14, 2021
  • Asia-Pacific Financial Institutions Monitor 4Q2020: Downside Risks Dominate, Oct. 19, 2020
  • The Stress Fractures In Indian Financial Institutions, Nov. 24, 2020
North America:
  • Earnings Among Large U.S. Banks Rebounded In Third Quarter, But Uncertainty Remains High, Nov. 17, 2020
  • U.S. Bank Outlook 2021: Picking Up The Pieces And Moving On, Jan. 13, 2021
  • U.S. Banks Face Long-Term Risks To Their Commercial Real Estate Asset Quality, Nov. 16, 2020
  • Canadian Banks 2021 Outlook: Entering A Crucial Phase Of The Credit Cycle With Good Resilience, Dec. 8, 2020
Western Europe:
  • Capital Resilience Alone Won't Stabilize European Bank Ratings In 2021, Feb. 3, 2020
  • Low-For-Even-Longer Interest Rates Maintain Margin Pressure On European Banks, Feb. 2, 2021
  • European Banks' 2021 Stress Test Contemplates A Tough Adverse Macroeconomic Scenario, Feb. 1, 2021
  • U.K. Banks Face A Bumpy Road To Earnings Recovery In 2021, Jan. 11, 2021
  • For Italian Banks, The Big Test Could Come In 2021, Jan. 13, 2021
  • French Bank Outlook 2021: All About Efficiency And Asset Quality, Jan. 21, 2021
  • Spanish Banks Need To Bolster Provisions, Cut Costs, And Preserve Capital In 2021, Jan. 25, 2021
Latin America:
  • • Mexican Banks Brace For Widening Credit Losses, Oct. 26, 2020
  • • LatAm Financial Institutions Monitor 3Q2020: Climbing Out Of A Deep Plunge, Oct. 21, 2020
  • True Picture Of North African And Jordanian Banks' Creditworthiness Will Emerge In 2021, Feb. 1, 2021
  • Russian Banks Face A Tougher Path To Profit, Jan. 27, 2021
  • Credit FAQ: Why Russian Banks' Asset Quality And Credit Costs Remain Key For Investors, Dec. 15, 2020
  • GCC Banks: Lower Profitability Is Here To Stay, Oct. 13, 2021

This report does not constitute a rating action.

Primary Credit Analysts:Osman Sattar, FCA, London + 44 20 7176 7198;
Harry Hu, CFA, Hong Kong + 852 2533 3571;
Brendan Browne, CFA, New York + 1 (212) 438 7399;
Cynthia Cohen Freue, Buenos Aires + 54 11 4891 2161;
Secondary Contacts:Alexandre Birry, London + 44 20 7176 7108;
Gavin J Gunning, Melbourne + 61 3 9631 2092;
Mohamed Damak, Dubai + 97143727153;
Natalia Yalovskaya, London + 44 20 7176 3407;
Research Contributor:Mehdi El mrabet, Paris + 33 14 075 2514;

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