“Despite a multitude of factors at play, European banks maintain resilient credit profiles and solid financial fundamentals. However, our base case is for revenue growth to turn marginally negative in 2025 and remain neutral in 2026, while cost growth will outpace revenue growth over the next two years, driving a deterioration in efficiency,” said Marco Troiano, head of financial institutions.

Narrower net interest margins will marginally reduce profitability but Scope expects lower net interest income because of thinner margins will be partially counterbalanced by growth in loan volumes and higher levels of non-interest income (particularly from wealth and asset management and insurance activities).

Loan growth will accelerate in 2025-2026, driven by demand for consumer credit and a rebound in mortgage lending as the housing market recovers, borrowing costs decline, and banks ease lending standards. Business lending will be supported by economic growth and Covid-era loan refinancing.

“Asset quality will likely deteriorate, although lower borrowing costs and tight labour markets will support credit quality,” Troiano continued. “We expect any worsening in non-performing loan ratios to be manageable. Banks will set aside higher loan-loss provisions; many still have cushions of unused general reserves that can be deployed to absorb unexpected spikes in defaults, although we rule out a widespread default scenario.”

Capital ratios remain well above minimum regulatory requirements. Most banks will seek to reduce excess capital through continued distributions and through M&A. Banks’ capital buffers have settled around 4%, which Scope considers more than adequate. But the pace of capital generation will decrease as profitability moderates and revenue growth drivers shift from margins to volumes. Capital requirements will only moderately increase as Basel III is phased in.

Key sector themes to watch

Scope expects the consolidation theme to persist, as falling rates and normalising profitability will drive banks to find new sources of value creation. Excess capital and strong relative pricing positions make some banks natural consolidators.

Domestic M&A offers greater potential for value creation through cost synergies in physical distribution and overlapping central functions. “Synergies in cross-border deals are limited, given the lack of overlapping distribution networks while the potential for regulatory ring-fencing limits potential saves in funding costs. An incomplete Banking Union limits the fungibility of capital and liquidity across borders and political resistance can also hinder large cross-border mergers,” Troiano said.

Cyber risk is a growing threat to the industry. Cyber risk and data security are the most prominent drivers of operational risk for European banks. Operational risk accounted for roughly 11% of risk-weighted assets for our top 40 rated European banks in the first half of 2024. Despite higher investments in IT security, European banks have suffered a growing number of cyber-attacks. The ECB’s recent cyber resilience stress test shows that there are areas for improvement.

European banks could face a tripling of credit losses under the NGFS disorderly and hot house scenarios, according Scope’s recent climate stress test study .Banks need credible climate-change risk management plans and proactive engagement with clients to lower climate-related credit risks.

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