European Central Bank Banking Supervision reports wide variation in banks’ readiness to manage emerging SME credit stress

European Central Bank Banking Supervision published the findings of a targeted review of banks’ lending to small and medium-sized enterprises (SMEs), assessing how well institutions can detect and manage borrower distress at the onset of a potential crisis. The review concludes that preparedness differs markedly across banks, with weaker outcomes linked to limited automation and shortcomings in data and IT infrastructure, early warning capabilities, and sectoral risk management. The off-site review covered 14 entities of significant banks (nine banking groups) and four less-significant German banks, supplemented by a half-day workshop with each institution. It highlights high sectoral concentration in SME portfolios, with real estate exposures material across most countries, and notes that the SME non-performing loan ratio was 4.78% at end-Q1 2025 versus 3.47% for the total non-financial corporate portfolio, while the SME portfolio coverage ratio was 3.02%. Common gaps included delayed retrieval of borrower information, insufficiently conservative treatment of outdated ratings, over-reliance on ratings within early warning and credit processes, limited use of sector-specific early warning indicators, and thresholds calibrated to detect default rather than early deterioration (for example, alerts only triggered when interest coverage ratios fell below one or leverage exceeded ten). Sectoral risk frameworks were often absent or applied superficially and on an ad hoc basis, and the review found minimal practical differences between large and smaller banks’ approaches, partly reflecting shared systems within savings and cooperative banking groups.