European Banking Outlook: sound fundamentals support credit profiles but profitability will decline
“The sector will remain resilient this year, thanks to stronger credit fundamentals built over recent years. Downside risk and upside factors are broadly balanced,” said Marco Troiano, head of financial institutions ratings. “In our view, sector profitability will have peaked in 2023 and will start declining in 2024 and 2025 owing to a normalisation of net interest margins and a moderate increase in credit risk. Yet, none of the banks in our sample will report a net loss in 2024 under our base case.”
Downside risks include:
- any risk of economic recession in large EU countries, in particular a rise in unemployment that could have a deeper impact on asset quality;
- greater competition for deposits, both among banks and between banks and alternative savings products that could hurt revenues and profitability and, in more extreme scenarios, lead to funding shortages;
- a significant financial or geopolitical shock, undermining confidence in the sector, which, as the Silicon Valley Bank and Credit Suisse cases have shown, remains fickle.
Upside scenarios include:
- a steepening of the yield curve driving further expansion in net interest margins;
- faster than expected economic growth, supporting both volumes and asset quality;
- an acceleration in institutional reforms leading to completion of the European Banking Union and greater consolidation within the single market.
While policy rates will likely pivot in 2024, there is still near-term upside to bank revenues in the first half. Margins will start contracting at a moderate pace in the second half of the year, however, as competition for deposits increases following TLTRO repayments and the ECB accelerates quantitative tightening. “Growth in fee and commission income will not be enough to offset lower net interest income. As such, we believe overall revenues year will marginally decline this year and drive a mild deterioration in cost/income ratios, albeit from very comfortable levels,” Troiano continued.
Net interest margins peak in 2023
Source: Scope Ratings
Note: net interest margins calculated on total interest-earning assets
Asset quality will deteriorate in 2024 thanks to only modest economic recovery coupled with continued high borrowing costs. But we expect the increase in non-performing loans to remain modest and its impacts to be easily absorbed out of banks’ ordinary profitability.
“Pockets of credit vulnerability such as commercial real estate are unlikely to turn into a systemic banking issue given the adequate degree of diversification among Europe’s larger banking groups,” Troiano said, “while cost of risk will only increase modestly from current levels as banks still have large unused provisions overlays that should help smooth out the P&L impacts of credit deterioration, at least initially.”
And sign up for our webinar on Tuesday January 30th at 15:30 CET, when Marco Troiano will discuss the European banking outlook, including downside and upside factors. Register here.