European banks face disruptive retail funding dynamics
“In the short term, we believe the banks have the capacity to adapt. But for the banks most exposed to this trend, how they respond demands attention,” said Nicolas Hardy, Scope’s Deputy Head of Financial Institutions. “Failure to stabilise the trend could have structural implications on profitability and asset-liability management, including rising loan-deposit ratios and a greater reliance on wholesale funding.”
Household deposits have reached a tipping point: for the first time in 20 years they have started contracting. This is a fundamental change because access to cheap retail funding is a key component of European banks’ business models and profitability. Household deposits represent the bulk of deposits used to fund loans. Household deposits represented 30.3% of European banks’ total funding as of June 2023. Corporate deposits accounted for little more than half that number, 16.2%.
Household deposits, the lion’s share of European banks’ total funding
Ranking as of June 2023. Source: EBA risk dashboard
“Confidence and attractive pricing are vital conditions for retaining customer deposits. There is very little banks can do to prevent an exodus of deposits. What characterises the current trend is the growing customer focus on pricing,” Hardy said. “Deposit repricing has been earmarked as an indicator of fairness and banks have been put under the spotlight for being too slow to adjust rates on deposits. This argument is also being used with a political agenda to justify the taxation of banks’ ‘windfall profits’.”
Banks are likely to continue facing an erosion in their stock of core customer deposits. For more fragile retail clients, deposits compensate for falling real disposable incomes so some depletion of precautionary savings needs to be factored in. Wealthier clients may withdraw bank deposits in favour of better remunerated products that are not necessarily managed by banking groups.
In the low-for-long interest rate period, banks implemented strategies to channel excess deposits towards off-balance sheet investment products that generate fees and commissions. This becomes less of a priority if core customer deposits start to shrink and balance-sheet management becomes more challenging.
“Banks may be forced to look for alternative sources of funding, which will likely be more expensive. Optimising funding structures requires a constant fine-tuning of interest rates. The new retail funding dynamics are disruptive for banks because they are coming on top of other significant changes with a potential compound effect, such as access to central bank funding with the accelerated repayment of TLTRO III,” Hardy said.
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