• Bank deleveraging slowing but total assets still to fall slightly in 2013
• Bank lending will stabilize this year and should pick up in 2014
• Non-performing loans to peak this year, driven by high rates in the periphery
• Interest rate rises remain an outside risk but insurers need to plan a response

The Cypriot debt-crisis is a timely reminder that the problems in the Eurozone are not over and that economic recovery for the region is on a fragile, uneven trajectory, but the Eurozone Financial Services Forecast predicts that, while localized problems can’t be ruled out, the collective pain for the financial services sector in the Eurozone is almost over. Many key indicators for the sector are expected to return to modest growth in the next 18 months, and banks in particular should be in a position to start lending and help drive the economic recovery in 2014.

Andy Baldwin, Head of financial services, Europe, Middle East, India and Africa at Ernst & Young comments:
“The market response to the Cypriot debt crisis was actually fairly encouraging in that it demonstrated that the major European economies are now quite well insulated from national crises in smaller states. The financial services sector remains the principal mechanism for distributing investment capital to the wider economy and it now needs to play a vital role in the economic recovery”.

Gelu Gherghescu, Assurance & Advisory Partner at Ernst & Young Romania comments:
“There is a sense that the Eurozone financial sector has overcome most of its issues. However, the forecasts are divided between North and South as well as between large systemic financial institutions which continue to strengthen respectively smaller banks for which the outlook is less certain.

The most challenging phase of bank deleveraging is over
After contracting by EUR 856b last year, total assets in the Eurozone banking sector are forecast to fall by EUR 500b in 2013 before returning to growth in 2014. Total assets have already broadly stabilized in Germany, France and The Netherlands, while Italy and Spain are expected to follow next year.
Marie Diron, Senior Economic Adviser to The Eurozone Financial Services Forecast says: “Although on aggregate deleveraging in the Eurozone will continue at some pace this year, we believe the most destructive phase has now passed and that banks in the stronger economies have already turned the corner. 2013 should be the last year of asset shrinkage, and 2014 is looking much healthier.”
Lending to fall by 0.5% but to return to growth in 2014
Lending to businesses and households fell 1.7% across the Eurozone last year and this contraction is expected to continue in 2013, but at a slower rate of 0.5%.
There is still a pronounced North-South divide in the cost of bank borrowing and as a result the peripheral economies will experience a more marked contraction in lending this year. Lending in Spain is forecast to contract by 5.1% in contrast to positive growth of 0.8% in Germany and 0.6% in France. However, total lending across the Eurozone is expected to start to grow again in 2014 at a rate of 2.9%, which includes a modest (0.9%) return to growth in Spain.
Banks’ access to wholesale funding markets is continuing to improve, and private sector deposit flows in the periphery appear to be stabilizing, allowing banks to gradually transition away from central bank support, but credit conditions are likely to remain tight for some time, which will weigh on investment and consumer spending.
Non-performing loans will peak this year, driven by peripheral economies
As a result of the rise in NPL rates in the peripheral economies NPLs in the Eurozone will peak at a Euro-era high of 7.2% this year, up from an estimated 6.7% at the end of 2012. Non-performing loan (NPL) rates are already declining in France, Germany and The Netherlands this year but will climb to a peak of 10.2% in Italy and are forecast to reach 12.8% in Spain, notwithstanding the recent transfer of problematic assets to SAREB .
“In Romania I’d rather expect no lending growth during the next nine months, with a slight growth of lending to businesses and a stronger one for mortgage loans but a decline of consumer loans. This stems from the weak confidence of consumers and decision-makers in the short-term perspectives of the economy but also from the limited and selective appetite of certain players. Anyhow, even a slight increase in lending would not be sufficient to support the economic growth to such an extent to contribute significantly to limiting the evolution of non-performing loans. Thus, although at a lower step, the non-performing loans will continue to grow during the next 6-9 months. Consequently, as regards the evolution of lending and non-performing loans we are to some extent in a vicious circle” explains Gelu Gherghescu.
Interest rate rises remain an outside risk but insurers need to plan their response
Concerns that the economy could gather pace more quickly than anticipated under our baseline forecast, causing the ECB to increase rates more quickly should be taken seriously by insurers. If the Eurozone does not shrink this year and grows by 1.7% in 2014, which is faster than the 1.1% baseline forecast, inflation would then hit 2.8% by the end of 2014, causing the ECB to increase interest rates from 0.75% to 1.25% in 2015, rather than keep them on hold until the middle of 2017. Ten-year Eurozone government bond yields would rise from 3.4% in mid-2014 to 4.7% by the end of 2015.
Andy Baldwin adds: “The rapid rise in interest rates and higher financial stress would hit insurers through their bond-heavy balance sheets. Insurer’s core business would also be affected with lapse rates likely to rise, for example, as customers switched into alternative products offering higher yields, and new business would suffer as the economy slows.”
“Despite the low probability of interest rates rising the effects are large enough to require scenario planning by insurers. However, for the local market, such a scenario should also lead to a reduction of the country risk spread for fixed income instruments, including Romanian treasury bonds, compensating partly for the increase in the market rates”, comments Gelu.
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