(Bloomberg) --

The European Central Bank said its supervision arm will focus its scrutiny in the coming three years on risks that lenders face from a potential spike in bad loans and their search for higher returns. 

Several early indicators point to a possible deterioration in credit quality, senior ECB officials said in a blog post on Tuesday. The rate at which banks are reclassifying loans as riskier is twice as high as before the pandemic, and the share of loans under forbearance has risen, they said.

European banks benefited this year after unprecedented support by taxpayers cushioned the pandemic’s blow to the economy. Many lenders bolstered their profits by freeing up money they had stashed for bad loans while others are taking more risk in businesses like leveraged finance.

“A possible deterioration in asset quality, linked to the progressive withdrawal of public support measures along with downside risks to the economic recovery, calls for supervisory attention,” Andrea Enria, who leads the ECB’s oversight arm, said in a blog post. 

NPL ratios in sectors more vulnerable to the impact of the pandemic have also started increasing. This is especially noticeable in accommodation and food services, and the air transport and travel-related sectors, the ECB said.

Together with officials from national authorities, the ECB will monitor “the build-up of unmitigated risks” in leveraged finance and banks’ “strict adherence” to guidance it has provided on the business. It will also conduct on-site inspections to look at how banks are managing counterparty credit risk, including in prime brokerage and leveraged loans.

The ECB is also pushing lenders to prepare for other risks, such as those they face from climate change and will conduct a stress test in this area next year.

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