A majority of Europe's banks have suffered a jump in bad loans even as investors lined up to lend them money, according to a study by Fitch, the rating agency.
Impaired loan volumes rose 8.1 per cent in 2013 to slightly more than €1tn compared with the year before, said the Fitch analysis, which used banks' financial results for the years ending 2012 and 2013.
"It's a dose of realism," said Robert Montague, senior banks analyst at ECM, an investment manager. "It reflects the fact that banks were under-recognising and under-provisioning for bad loans, mostly in periphery countries but not exclusively."
Ahead of a regional assessment of banking assets later this year European regulators are set to adopt a strict classification system, which seeks to eliminate national differences over what constitutes a problem loan.
Fitch surveyed a hundred banks due to be assessed by the European Banking Authority.
Twenty-nine saw the number of impaired loans rise by more than 20 per cent as their asset quality deteriorated, while one-third of banks saw their bad loan volumes fall or stay the same.
"The increases were caused partly because of a switch to a more conservative loan classification and partly due to a deterioration in the quality of banks' assets," said Michal Bryks, financial institutions director at Fitch.
In spite of a rise in bad loans, the cost of funding for Europe's banks fell 38 per cent last year, according to the iTraxx senior financials index, which measures the cost of insuring against bank default.
Funding costs have continued to fall this year as banks exploit record low-interest rates by tapping into investor appetite for higher-yielding assets and issuing large numbers of bonds.
The turnround has been remarkable for banks on Europe's periphery, many of which received billions of euros in state aid during the eurozone sovereign debt crisis, where issuance has increased by 72 per cent year-on-year, according to Dealogic, the data provider, following big increases in 2013.
Banks' impairment reserves, which are meant to cover loan losses, rose 7.5 per cent last year to €570bn, according to Fitch. European banks such as those in Italy have increased provisioning still further this year ahead of the stress tests by the European Banking Authority.
"Problem loans have a direct and material effect on a bank's results, regulatory capital reporting and market valuation," said Mr Bryks. "In light of the upcoming asset quality review a lot of banks thought it was a good time last year to recognise bad loans and avoid nasty surprises."
Spain, meanwhile, issued its first ever inflation-linked bond on Tuesday, raising €5bn for the inaugural "linker" after banks on the deal were flooded with more than €20bn of orders despite concerns over subdued eurozone inflation.
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