Eurozone bank balance sheets to shrink by €1.6 trillion in 2012: Ernst & Young

Eurozone's banks will see their balance sheets shrink by €1.6tr in 2012, as the result of disposals of non-core assets and a contraction in lending, Ernst & Young Eurozone financial services forecast  warned in a study that draws attention to the delayed impact of the current Eurozone turmoil on financial services and the role they will play in the economy during 2013.

Andy Baldwin, leader of E&Y's financial services for Europe, Middle East, India and Africa at Ernst & Young, says, ''Investors are frustrated with short-term quick fixes to the sovereign debt crisis and are looking for a more fundamental solution. The Eurozone financial services sector continues to be hit by a combination of the deteriorating economy and the recurrent crises of confidence in the market. While the effect of this on bank balance sheets in 2012 is worrying, the real impact of this year of Eurozone turmoil will not be seen until 2013, when non-performing loans will hit harder than many are expecting.''

The downgrade of the forecast for Eurozone GDP, with a contraction of 0.6 per cent now anticipated in 2012 and modest growth of just 0.4 per cent in 2013, means that the outlook for non-performing loans (NPLs) has worsened again. In March, the forecast predicted that this year NPLs would rise to their highest level since the creation of the common currency. The forecast for NPLs at the end of 2012 is little changed (6.2 per cent of outstanding loans), but we now expect NPLs to continue rising to a peak of 6.5 per cent in 2013 – a record high for the common currency.

Marie Diron, economic adviser to the Ernst & Young Eurozone financial services forecast said, ''NPLs tend to lag the economic cycle and are a ticking time bomb for the Eurozone economy. The fact that the EEFS forecast for Eurozone GDP has been downgraded again has worsened the forecast for NPLs, pushing the peak out to 2013. Many banks are also carrying high levels of loan forbearance, which is masking the true extent of their non-performing portfolios. As the economy continues to worsen, a larger portion of these loans will be pushed into NPL status, forcing banks to realise their losses and constricting further lending.''

Bank balance sheets to shrink faster than during the financial crisis
The forecast predicts that the Eurozone's banks will shrink their balance sheets by €1.6tr in 2012, as the result of disposals of non-core assets and a contraction in lending activity. In particular, the contraction in corporate lending and consumer credit will be even more severe than the EEF envisaged last quarter. It is now expected that corporate loans will contract by 4.8 per cent this year while consumer loans will fall by 6.6 per cent – each representing the fastest pace of contraction for these loan categories on record for the Eurozone.

Dion said, ''This will have a significant impact on the wider Eurozone economy; it represents a sharper shrinking of balance sheets than during the 2008-09 financial crisis. It is in part reflective of lower demand for loans but it will exacerbate the current credit shortages  - larger firms will be able to draw down their cash balances or access alternative sources of funding, but smaller firms will struggle to access funding.