What are the Elements of Credit Risk

Credit risk depends on 5 factors

Every year the ECB banking supervisory authority prepares a risk map in cooperation with the national authorities, which can be used to read off the main risk factors for the next two to three years. The risk constellation in "" (short:) not only depicts the probability of occurrence and impact intensity, but also emphasizes the dependencies and mutually reinforcing elements of the individual risk factors. In this way, a total of eleven main risk factors were identified that will primarily affect banks in the euro area in 2020 to 2022. In addition to Brexit and the risk of cybercrime, it is above all outdated business models and general challenges in the areas of economy, politics and debt sustainability that the ECB believes will burden the euro area.

There are five main factors that increase credit risk

Figure 01 clearly shows the results of the analyzes after.

Above all, five risk factors combine a high probability of occurrence with a strong impact:

  • Economic, political and debt sustainability challenges in the euro area;
  • Sustainability of the business models of European banks;
  • Cyber ​​crime and IT deficiencies;
  • Execution risks in NPL strategies (= non-performing loans, only affects banks with high NPL portfolios);
  • Relaxed lending guidelines.

The urgent advice from the ECB, which is provided by this investigation between the lines, is clear: Any bank that wants to successfully extend a loan in 2020 and beyond should take a closer look at its own, especially with regard to these five points.

Figure 01: Risk constellation in 2020 [Sources: ECB and NCAs]
Notes: * The execution risks associated with banks' NPL strategies apply only to banks with high NPL holdings. ** The risks caused by climate change are more relevant in the longer term (i.e. over a time horizon of more than three years).

Economy, politics and debt sustainability as stressful factors

The risks for the euro area resulting from the economic and political conditions have increased compared to the previous year. This is mainly due to a downward revision of economic expectations and a more tense mood in the international environment. The increasingly prevalent protectionism also leads to an increased credit risk for banks whose customers depend on stable exports. At the political level, some more and more nationally oriented EU countries also lead to challenges in the euro area.

Added to this is the consistently high level of debt of both private households and, above all, of European companies, which are currently benefiting from the low interest rate level. Even if interest rates are likely to remain low for the time being, the high debt burden still makes companies vulnerable to shocks, which also increases the credit risk for banks.

Banks' business models are no longer up to date

The business models, especially of the big banks, are geared towards completely different conditions than the bankers will experience in 2020. The persistent low interest rate environment and the resulting low interest rate contribution will continue to weigh on the profitability of the banks in the new year, which will continue to force them to develop alternative sources of income.

Due to fixed structures, sometimes huge machines and the often lacking "startup spirit", however, they are often much worse positioned than the flexible, young competition of FinTechs, especially when it comes to the question of which possibilities advancing digitization provides for innovative expansions of business models. In addition, more and more competitors in the form of global players from the BigTech sector such as Apple or Google are emerging.

In order to remain profitable in 2020 and beyond, banks will have to reinvent not just their business models, but their role in society and thus themselves.

Many banks' IT systems are vulnerable to cybercrime

The advancing shift of almost all areas of life into the digital sphere is simultaneously leading to an increase in cyber crime. This trend will continue increasingly in the following years and thus also represent a growing one for banks. The sensitive business processes are currently still very often processed in outdated systems, the conversion of which is associated with high organizational and financial costs.

Outsourcing the bank's internal IT services to a third party is therefore a common practice. The resulting interfaces, however, in turn lead to operational risks. The past has already shown the considerable reputational damage security incidents in the IT area of ​​banks can have.

The particular credit risks: Non-performing loans

Banks with high holdings of non-performing loans (, NPL) have made generally good progress in executing their respective NPL strategies in recent years. At the major institutions, the NPL holdings fell by EUR 112 billion between Q1 2018 and Q1 2019, to just EUR 587 billion. This reduction is also reflected in the average NPL rate of 3.7 percent, which was 4.7 percent in the previous year.

However, despite these intensive efforts by the banking sector, the credit risk emanating from non-performing loans in the euro area is still higher than it was before the financial market crisis. Compared to other industrialized nations, the risks are even significantly higher.

In view of the advanced economic cycle, these credit risks continue to severely limit the banks' ability to act. The banking supervisory authority is particularly critical of the fact that if these non-performing loans are finally defaulted due to another crisis.

Relaxed lending guidelines could do more harm than good to banks

Lending guidelines were tightened significantly during the financial market crisis. The renewed relaxation of these requirements makes it easier to grant loans, which, especially in times of low interest rates and investment pressure, can lead to an increase in non-performing loans. The credit risk for banks is primarily increased by the loose granting of residential property loans, as they have on average many such loans on their books.


The slowly weakening economy is fueling fears of a recession and is therefore directly or indirectly reflected in all the points highlighted by the ECB banking supervision. The development is overshadowed by the persistently low profitability of the banks due to the low interest rate phase, increasing competition from non-industry sectors and the pressure to innovate, which makes investments necessary in order to develop viable business models in the future. In addition, there are the necessary investments in the modernization of existing IT systems in order to minimize the increasing risk of cyber attacks and lower operational IT risks.

Politicians, which for their part generate their own risks through nationalist trends and protectionism, try to support the banks, for example by easing lending guidelines. However, this could be counterproductive in the long run, as it could increase rather than decrease the still high levels of non-performing loans.
In the event of a shock, the ECB sees that the banks will not be able to support the rest of the economic players because of these burdens, but will themselves become problematic again.


Ben Korbach
worked for many years in the corporate customer area of ​​a major German bank until he realized that this was no longer his way. Since then he has been traveling the world with his wife and working as a corporate coach and strategic content partner wherever there is internet. His specialty is asking the right questions and translating the often complex answers into simple, story-based texts. Among other things, Ben Korbach has specialized in the subject of loans.

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