Luxembourg’s banking sector has remained resilient in recent quarters, despite a rise in non-performing loans (NPLs)--loans that have either defaulted or are at risk of defaulting--thanks to strong capital positions and ample liquidity buffers. The NPL ratio across all loans rose to 2.3% in the fourth quarter of 2024, reaching its highest level since the first quarter of 2017, recent data from the International Monetary Fund shows. This increase has been attributed to a combination of factors, including the broader economic slowdown, rising interest rates and specific vulnerabilities in the real estate sector, particularly within commercial real estate and construction, explained the Luxembourg Central Bank (BCL).

Increase in NPLs

“Over the past years, increased inflation, higher interest rates and heightened levels of geopolitical uncertainties have been weighing on economic growth both in the euro area and Luxembourg,” said a BCL representative. For Luxembourg, this slowdown has been most evident in the real estate market and bank credit flows, which have contributed to an increase in bankruptcies among non-financial corporations (NFCs), especially in the construction and real estate sectors.

The BCL closely monitors credit risk in both the household and NFC sectors. The representative elaborated that “for households, the NPL ratio increased by 0.1 percentage points year-on-year to reach 2.1% in 2024Q4.” However, the increase in the NFC sector has been more pronounced, with the NPL ratio rising by 0.8 percentage points to 3.4%. “For households and NFCs combined, the NPL ratio increased by 0.5 percentage points, reaching 2.9% in 2024Q4.”

Real estate and SMEs

Notably, the increase in NPLs within the NFC sector has been driven by vulnerabilities in cyclical industries such as small and medium enterprises (SMEs) and commercial real estate (CRE). Both SME and CRE NPL ratios increased, reaching 6.6% and 10.2%, respectively, in the fourth quarter of 2024.

Despite these increases, the exposure of Luxembourg banks to these sectors remains limited, representing only 1.6% and 1.4% of their aggregate balance sheet in the same period. The BCL argued, “these results indicate that, despite the recent increases in NPL ratios, the asset quality deterioration remains manageable for Luxembourg banks.”

Strong capital and liquidity buffers

“The increase in NPL ratios in the non-financial private sector is currently manageable for Luxembourg banks, notably in view of both high levels of solvency and liquidity ratios and strong levels of profitability,” stated BCL. As of Q4 2024, the aggregate total capital ratio stood at 19.9%, or 22.6% using the IMF sample. Both the liquidity coverage ratio and the net stable funding ratio were well above the minimum requirement of 100%, at 167.6% and 124.5%, respectively.

NPL provisions

In reference to Luxembourg banks’ NPL provisions--funds set aside to cover potential losses from loans unlikely to be repaid--now standing at 7.3% of bank capital, the highest level since 2017, the central bank representative clarified that “Luxembourg banks most exposed to the cyclical downturn in the real estate sector have increased their provisions as a precautionary measure,” and that “NPLs for both households and NFCs remain well covered in terms of provisions, collateral and guarantees.”

“Such increases in provisions reflect rather sound credit risk management practices,” emphasised the BCL.

Bank profitability

“Increased provisioning did not negatively affect the profitability of Luxembourg banks,” added the BCL representative. Bank profitability, as measured by the aggregate return on equity (RoE), increased by 1.1 percentage points, from 9.8% in 2023 to 10.9% in 2024. While net interest income has slowed, expanding by only 3.9%, there has been a significant rebound in net fees and commission income, which increased by 10.3% in 2024.

Banks’ perspective

A representative of the Luxembourg Bankers’ Association (ABBL) also commented on the rise in NPLs, attributing it primarily to the commercial real estate sector. “In times of economic slowdown, such as we are currently experiencing, it is always commercial real estate, which is a riskier activity, that suffers first,” they noted. They further highlighted the stability of Luxembourg’s banks, pointing out that their capital ratios are well above both the minimum regulatory requirements and the European average. These capital buffers “have been built to absorb a range of shocks, including those arising from difficulties in the construction market.”

The ABBL representative also stressed the prudence of Luxembourg’s lending policies, noting the dual responsibility that banks have towards both their customers and borrowers. “Banks have always pursued a prudent lending policy that takes account of their dual responsibility: towards their customers who have entrusted them with deposits and who should not be put at risk by risky lending policies, and towards the people or companies to whom they grant loans and who should not be put in a position where they cannot repay them,” they stated.

Overall, despite the rise in NPLs, Luxembourg’s banking sector remains well-capitalised and able to withstand further deterioration in loan quality, both the BCL and the ABBL have assured. They also asserted that the increase in NPLs is currently manageable and that Luxembourg’s banks are well-equipped to absorb potential further shocks.