We ask whether non-performing bank loans in Europe will rise because of high inflation and high energy prices and the fallout from the war in Ukraine.
We update our NPL forecasts by country and economic sector based on the macroeconomic scenarios of the World Economic Outlook published by the IMF in April.
While the IMF outlook accounts for higher inflation and lower growth in 2022 and 2023, it does not consider a full boycott of Russian energy which would likely cause a recession in the Eurozone. We find evidence that the current high levels of inflation can materially increase default risk. We project higher defaults for instance in Italy and the UK, while Germany and France appear to be less impacted.
Our findings contradict research studies which assume and observe that inflation and loan defaults are negatively correlated, i.e. inflation decreases in a downturn when NPLs increase. We caution that models reflecting such a negative sensitivity to inflation may underestimate credit risk in a stagflation scenario where economic output declines while prices increase further. We acknowledge that model uncertainty is high and that we do not explicitly account for government support measures which have been effective in avoiding new NPLs during the recent Covid recession.
We identify the most energy intensive business sectors, but find that inflation and oil prices impact other less energy intensive sectors as well. While some companies benefit from higher prices, many households are currently suffering from high inflation leading to more energy poverty which combined with an increased debt burden from higher lending rates will increase the credit risk of loans to consumers.
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