, partner and banking and capital markets leader at EY Luxembourg, opened the firm’s annual banking conference on 26 November 2024 by highlighting a few data points from the country’s banking sector.

When it comes to banks’ exposure and risk, Luxembourg has “significantly less” stage 2 exposure compared to other countries, he said. Exposures that are classified as stage 2 mean there is a significant increase in credit risk. On one hand, this could be seen as “good news” and a sign that Luxembourg portfolios are better than in other countries. But it’s not necessarily something positive, he added, as it could mean that in Luxembourg, “we collectively do not identify enough exposure which are performing, but not as much as expected.” This could be due to a lack of data and the inability to assess how counterparties are doing over time. “That remains a key area of attention, to make sure that you can capture these counterparties that are getting into difficulties before they default.”

Rigaud drew attention to a second data point related to stage 3 exposure, or default exposure. “What we observe in Luxembourg is that since 2022, there has been an increase of 23% of default exposure.” The figure for Germany is higher (34%), but comparing Luxembourg to the rest of Europe, it’s “quite” significant, he said. A possible explanation could be the small size of the grand duchy, making it “more dependent on idiosyncratic factors.”

Non-performing loan ratios

The non-performing loan ratio (the level of non-performing loans compared to the total portfolio) is another data point that has been increasing, rising from 1.2% in Luxembourg in 2021 to 1.7%. “1.7% is not too bad. If you look at the rest of Europe, it’s quite good, but the trend is clearly increasing and it’s increasing more. The curve is steeper than in other countries,” said Rigaud. “Again, the size of the country probably makes a difference, but again, here [the default exposure] is increasing more than in other countries.” It’s important for banks to take this into account in their risk management.

Real estate is a particularly relevant sector for Luxembourg banks. The ratio of non-performing loans has “clearly increased” with the higher interest rates. It’s now almost at 6%, “which is quite significant” and much higher than in the rest of Europe. “This is really an area for attention.” There’s some good news when it comes to the ADC portfolio, or acquisition, development and construction. This ratio has increased a lot, but it is now decreasing, said Rigaud. However, it’s an “open question” as to whether that’s because the situation is improving or because “we have less portfolio.” These are key ratios to keep an eye on, he said.

Other key ratios to keep in mind are the return-on-equity and the cost-of-income ratios, noted Rigaud, which he believed were “still too far from reality.” Because interest margins continue to be big, the cost-to-income ratio “seems really good.” Today, it looks like 40%, but looking at the average from the previous five or 10 years, that ratio is far from 40%. It will be important for banks to work on cost and transformation programmes so that when interest margins are lower in the future, they are still capable of delivering--all while maintaining costs under control. “That’s why investment in IT and others is really key.”

“Positive” business outlook

Looking on the bright side, the business outlook is “quite positive,” said Rigaud, referring to a survey conducted by EY. “The outlook for next year about business growth is positive on the lending portfolio across Europe.” That being said, there are discrepancies between countries. Germany and France are struggling, for instance, while others are doing much better. But “overall, the situation is positive, and in Luxembourg we are impacted by all these countries, so we should benefit from this positive outcome.” The grand duchy should also benefit from lower interest rates to boost growth, though geopolitical factors are something to keep on the radar.

Market trends

Grégoire d’Avout, partner in EY Luxembourg’s strategy and transactions service line, covered some market trends observed in Europe. “If we look at the overall banking sector across Europe, we can see that over the last 15 months, it has largely over-performed the rest of the business,” he said. The increase in interest rates has helped boost activities, but there are other factors that have contributed to its performance. Banks in Europe have been able to improve their liquidity-coverage ratio (and have done better than the US) and have also been better able to manage the beta on their deposits. The CEOs of major banks, he pointed out, have been “very positive” in their recent communications. The share prices of banks have increased over the last 12 months, d’Avout added. “We are really in a positive trend.”

On M&A, major drivers of acquisition include the “need for scale,” fee income growth, digital transformation and ESG capacity. On the other hand, reasons for divestment include portfolio rationalisation, regulatory developments, the disposal of non-performing loans (this hasn’t been the case in Luxembourg, noted d’Avout, but it has been seen in France, Italy and Spain, for instance) and private equity activation.

Focusing on Luxembourg, “what we see is that we have more and more concentration.” Small, independent players are seen less and less. When it comes to transactions, however, 2024 has been “very quiet.” There are some transactions in the pipeline, but they haven’t yet materialised. To sum up the market in a few words, “everybody wants to buy, but we are clearly missing targets,” said d’Avout. “Everybody wants to buy; nobody really wants to sell. The positive interest margins probably over-boosted revenues over the past years, but I am not sure that it’s really sustainable.”

Regulation

Experts also covered regulation and reporting requirements that banks should keep an eye on in the near future in the spheres of payments, ESG and taxation.