Euro area bankruptcies rise, bank loan books stay resilient

Corporate bankruptcies in the euro area have increased markedly since the withdrawal of pandemic-era support measures, now surpassing pre-pandemic levels and broadening across sectors.

Despite this, banks' aggregate corporate asset quality has remained robust, with no broad-based deterioration in their loan books.

This divergence is partly explained by the normalisation of firm turnover since the COVID-19 pandemic, as suppressed insolvencies "caught up".

However, bankruptcies have continued to rise beyond this normalisation.

Firm-level evidence suggests that balance sheet and profitability challenges are concentrated in a vulnerable tail of firms, while remaining stable for the average euro area company.

Micro and small firms account for much of the recent rise in insolvencies, which has a contained impact on the aggregate corporate NPL ratio as SME lending is only around 27% of total corporate lending.

A long-running shift in corporate financing towards deprioritising bank credit forms a key background to the disconnect between rising bankruptcies and resilient bank asset quality.

Over the past two decades, euro area non-financial corporations have become less reliant on bank loans, with equity, debt securities, and non-bank lending playing an increasingly important role.

This implies that a greater share of corporate risk might now reside outside the traditional banking system.

Furthermore, banks have proactively managed non-performing loans, and the analysis finds no systematic evidence for delayed recognition.

Instead, weaker firm fundamentals are shown to result in a higher probability of reclassification from performing to non-performing exposures.