Financial reporting of European banks: an overview of expected credit losses indicators against a backdrop of continuing uncertainty in YE 2023

After several years of significant macroeconomic and geopolitical events such as the Covid-19 crisis, the war in Ukraine, the return of inflation and rising interest rates, the year 2023 seemed to mark a form of stabilisation in the international environment in the absence of any notable new event, despite the continuing uncertainties.

How has the absence of any significant event coupled with persistent uncertainty been taken into account by Europe’s largest banks in their expected credit losses for their YE 2023 financial reports?

To better understand credit risk trends, Forvis Mazars conducted an analysis of 26 banks in 11 European countries in June 2024, based on the banks’ year-end 2023 financial statements. The benchmark study on the Financial reporting of European banks [1] follows on from previous editions of the report since its launch in 2020.

A continued overall decrease in credit risk

At the level of the sample, credit risk as of 31 December 2023 shows a continued decrease since the peak of the Covid-19 crisis in YE 2020, which is particularly visible through the evolution of two fundamental credit risk indicators:

• the share of expected credit losses (ECL) charge in operating profit or loss before ECL; and
• the amortised cost loan coverage ratio, which is obtained by dividing the amount of ECL allowances provided for in the balance sheet by the gross carrying exposure of amortised cost loans.

Regarding the first indicator, the net ECL charge absorbs on average 16% of the operating result (before ECL charge) in YE 2023 compared to 20% in YE 2022. The decrease in this ratio can be explained by both a stabilisation of the average net ECL charge (-3% compared to YE 2022) and an average increase in operating profit or loss before ECL for most banks in the sample (+48% vs YE 2022). If we take the median value of this ratio rather than the average, the reduction is even more marked, with the median at 13% in YE 2023 compared with 18% in YE 2022.

This general trend is also supported when comparing the changes in the gross carrying exposures and the ECL allowances in the banks’ balance sheets between YE 2022 and YE 2023: globally, gross credit exposures are stable on average (+0.3%) whereas ECL allowances share a different trend as they show a slight average decrease of -1.7%.

As a result of the changes in these indicators, it would seem logical that the amortised cost loan coverage ratio for the sample is also falling to some extent, which is indeed what we are seeing in figure 1 below: the average amortised cost loan coverage ratio decreased compared to 2022 (1.36% in YE 2023 vs 1.40% in YE 2022). On a broader time scale, this ratio has been steadily decreasing since the YE 2020 when it stood on average at 1.83%, to the point where it is now, below the pre-crisis covid level at the end of 2019 (1.57%). This trend is also fairly consistent between the most represented countries of the panel (i.e. France, Spain and United Kingdom that represent together 50% of the panel).

The first lesson of the Forvis Mazars study therefore shows a general decrease in the level of credit risk compared to YE 2022 but also in the long run since YE 2019.

However, when we look at the details of these indicators at the level of the banks in the sample, we see that this consistent and marked general trend reveals contrasting situations.

A general decrease in perceived credit risk masking contrasting situations in YE 2023

Behind the clear general trend that emerges from the study of the relevant indicators for analysing credit risk, there are diverse situations within the sample.

Although the overall change in ECL charge appears relatively stable (-3%), the sample is in fact fairly balanced between banks that have seen an increase in their ECL charge (11 banks) and those that have seen a decrease (11 banks).

The same observation can be made about ECL allowances on banks’ balance sheets: only a small majority of banks (14 out of 26) experienced a decrease in their ECL allowances. For most of them, this decrease was achieved in proportions that were largely more than the evolution of gross carrying exposures, while the banks that saw an increase in their ECL allowances experienced more limited variations on average, resulting in an overall decrease in the ECL allowances in YE 2023.

As regards the amortised cost loan coverage ratio, although most banks (17) show a decrease in their coverage ratio, we still observe significant diversity in the levels of the global ECL coverage ratio as illustrated in figure 2 below. Despite a fairly good consistency in each country, the gap in this ratio between the different countries in the sample remains relatively wide, although it has been continuously narrowing since YE 2020 (between 0.3% and 2.8% in YE 2023 compared to 0.3% to 4.2% in YE 2020).

Finally, it is also interesting to note that the allocation by stage of amortised cost loans gross carrying exposures remained stable in YE 2023 compared to YE 2022 (88.7% allocated in Stage 1 and 2.2% in Stage 3), as did the allocation of amortised cost loans ECL allowances (13.5% in Stage 1 and 61.1% in Stage 3), but also showed contrasting situations within the sample:

• as regards gross carrying exposures allocation by stage, figure 3 shows that the sample is fairly balanced between two contradictory movements: banks generally either decreased their stage 1 gross carrying exposures in favour of stage 2 and stage 3 (to a lesser extent) or increased their stage 1 to the detriment of stage 2 and stage 3;
• for ECL allowances allocation, figure 4 shows that most banks increased their stage 3 ECL allowances to the detriment of stage 1 and/or stage 2, but a few banks largely decreased their stage 3 in favour of stage 2 or stage 1.

Despite an overall clear and consistent trend in YE 2023, the second lesson of the Forvis Mazars study is that we can see more diversity at an individual level compared to YE 2022.

We will see in a future article whether post-model adjustments to ECL allowances, which have become a significant part of the ECL assessment, also follow this trend and are consistent with the credit risk indicators analysed in this article.

[1] Financial reporting of European banks: benchmark study 2024 – Forvis Mazars Group

[2] Gross Carrying Exposures