(Bloomberg) -- Europe’s banks have remained sanguine on their outlook for this year, a war on their doorstep and rampant inflation notwithstanding. It’s dawning on them that 2023 could be much worse.

Top executives from Deutsche Bank AG to ABN Amro Bank NV are predicting a recession next year that could burden them with souring loans. European watchdogs monitoring systemic dangers warned of increased “tail risks” for the industry. And in the background, some regulators are already in talks with lenders to remind them of the need to preserve capital.

“We have the ingredients for a perfect storm” in the economy next year, Raimund Roeseler, the head of banking supervision at Germany’s financial watchdog BaFin, said Wednesday.

The change of tone comes as surging energy bills are threatening to put companies out of business and runaway inflation is leaving consumers struggling to pay their bills. While European lenders so far are still reaping the benefits from rising interest rates and a market volatility that’s fueled trading revenue, there’s a growing realization in boardrooms from Frankfurt to Amsterdam that there’s a flip side to both. 

Their views increasingly coincide while opinions elsewhere remain divided over just how deep the contraction might be. Billionaire Citadel founder Ken Griffin said on Wednesday that US consumers are spending more on things like airlines and electronics, which creates “a real powerful tailwind” to the economy. On the same day, famed investor Stan Druckenmiller said he’s not ruling out “something really bad” next year and that markets may stagnate for a decade.

The risk is particularly pronounced in Europe, where damage from the shutdown of Russian gas flows is piling up fast. Bloomberg Economics now predicts a roughly 1% contraction in the euro-region economy, starting in the fourth quarter. The drop could worsen to as much as 5% if there’s a harsh winter and the EU members fail to share fuel supplies. That would be about as deep as the recession of 2009. 

The European Systemic Risk Board, a body designed to monitor financial risk, last week took the unprecedented step to issue a general warning, according to a release on Thursday. A multitude of negative events have combined to create substantial perils to financial stability, such as sharp asset price drops and lower bank profits.

“A pronounced deterioration in the macroeconomic outlook would imply a renewed increase in credit risk at a time when some credit institutions are still in the process of working out Covid-19 pandemic-related asset quality problems,” the ESRB said in the release. Banks should ensure that “provisioning practices and capital planning properly account for expected and unexpected losses.”

There will be “a deeper recession in the next 12 months” in Europe and Germany, Deutsche Bank Chief Executive Officer Christian Sewing said in an interview Wednesday, adding he expects provisions for bad loans to increase. It’s imperative for the European Central Bank to “get inflation under control.”

Sewing’s counterpart at Dutch lender ABN Amro, Robert Swaak, struck a similar tone, predicting a recession in the second half of next year in an interview Tuesday. “The inflationary pressure is what everyone worries about,” he said.

Both lenders for now are benefiting from higher rates, which are boosting lending revenue. Sewing said momentum so far this quarter has been good and confirmed a profitability target for the year. Italy’s UniCredit SpA plans to “substantially upgrade” its guidance in the third quarter, CEO Andrea Orcel said last week. And Swaak signaled ABN Amro might give itself more leeway to reward shareholders with more buybacks. 

Such moves, however, are likely to be monitored closely by regulators, given the outlook for next year. While the ECB so far hasn’t indicated any concern, during the pandemic it did step in to curb payouts and ensure banks keep lending after being granted extra regulatory leeway.

BaFin’s Roeseler cited inflation and supply chain constraints as some of the biggest risks for the economy and noted the pandemic isn’t yet over either. While lenders in Germany are concerned and hence lean toward prudence anyway, BaFin is ready to give them a “push” if it wants to see even greater restraint, he said.

It’s inevitable that “the difficult economic environment and the high inflation will lead to more credit defaults,” the CEO of German regional lender Helaba, Thomas Gross, said Tuesday.

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