How long will European banks’ profit rally last?

EUROPEAN banks are raking in their highest profits since before the global financial crisis, as they benefit from an unprecedented series of rate increases that have driven a surge in lending income. The question is how long this can last.

Of the continent’s biggest lenders that have reported their 2022 earnings so far, 10 boosted net lending revenue by 16 per cent, to a record 120.8 billion euros (S$173.1 billion) last year. This fuelled them towards their highest profits since 2007, while setting off a cascade of dividend increases and buybacks.

With rates set to increase further, executives from Deutsche Bank and Nordea Bank have said the good times are not over yet.

But savers look set to start demanding their cut of the higher rates.

At first glance, European banks appear to be in a Goldilocks moment. Tighter monetary policy aimed at cutting inflation is letting them charge more for credit; at the same time, they are passing on just a fraction of the increases to depositors. The difference between the two is known as net interest income (NII), and it is surging.

But, at the same time, higher rates compound the squeeze on corporate and retail clients. Inflation is still through the roof, and recession fears are not yet in the rear-view mirror. This raises the prospect of higher defaults and a pullback by hard-up borrowers. Both of these could hurt bank’s balance sheets.

Francois Lavier, who helps to manage 35.9 billion euros at Lazard Freres Gestion in Paris, said: “After many years of shrinking revenues, the banks have turned into a growth story. That should continue in the euro area this year, but repricing can’t go on forever. If rates peak, the revenue increases will stop, as the repricing comes to an end, or we see another negative impact like more expensive deposits.”

The Federal Reserve, which started raising rates earlier than the European Central Bank (ECB), showed that banks could not rely on monetary policy to drive earnings forever. The Fed has since slowed rate hikes, and swaps are even pricing in cuts by year end. 

UBS Group chief executive Ralph Hamers said: “The interest income really came through. On the (US) dollar effect, we feel it has most likely peaked, however there is more to come on the euro and the Swiss franc.”

SEE ALSO

ECB plans next big rate hike, making Lagarde the last hawk standing

ECB raises rates again and plans at least one more hike

In contrast, the ECB lifted interest rates by 50 basis points on Thursday (Feb 2) and pledged another such move next month, before officials then take stock of where borrowing costs must go to tame inflation.

But several central banks in Eastern Europe are expected to cut borrowing costs later this year. Depositors in some countries are already looking for better interest rates.

Raiffeisen Bank International said on Wednesday that its NII in the Czech Republic took a hit of 8 million euros in the fourth quarter of last year. This came after the lender had to pay interest at a higher rate to its clients, as they moved money from current accounts to higher-yielding savings accounts.

Johann Strobl, the bank’s chief executive, said that dynamic “explains why (they were) not so enthusiastic anymore of a further increase in NII”.

Deutsche Bank signalled on Thursday that the bump to earnings from higher interest rates could be less pronounced in future years. This was partly because it would have to pay more to depositors. The German lender’s chief financial officer, James von Moltke, said it was “travelling well below” its previous assumptions of how much money it would need to pass on to clients.

European lenders might not pass on much of the gains right away. They could point to the precedent of initially shielding savers when the ECB took rates negative in 2014, with many ultimately only charging for money held with the bank at certain thresholds.

Tanate Phutrakul, chief financial officer of ING Group, on Thursday said: “So far, the rising rates by the ECB have been sharper than the rising rates in terms of deposits.” He said the Dutch lender was not facing difficulty in attracting such funding after it took in about 10 billion euros of retain deposits in the fourth quarter of 2022. But he noted that it would continue to watch competitors closely.

The other side of the equation is the risk of demand destruction, if clients decide that taking a loan is too expensive, curbing a bread-and-butter part of corporate and retail banking. 

The ECB said that lenders saw demand for corporate loans fall 11 per cent in the fourth quarter, while that for residential mortgages slumped by a record 74 per cent. A survey by the region’s central bank showed that banks were expecting demand from companies and households to decline further in the first three months of 2023.

Housing markets and global demand for home loans are sagging under the weight and speed of central bank rate rises. Onur Genc, chief executive of Spain’s Banco Bilbao Vizcaya Argentaria (BBVA), said the bank was expecting “slightly negative” growth in mortgages in its home country this year. He said it was relying instead on higher demand for consumer and corporate loans, notably from companies’ needs for working capital.

Banks, so far at least, have managed to avoid an increase in the share of bad loans on their balance sheets. But several are setting aside funds to cover loans going sour during a possible downturn. Genc acknowledged the risk that inflation and rates would have a knock-on effect on non-performing loan levels. He said that while BBVA had built buffers, it was also expecting loan-loss provisions to come in at about 1 per cent of loans in 2023, up from 0.9 per cent in 2022.

The Spanish lender said it still stood to boost revenue at a much higher rate.

Other bankers are also sanguine that the boost from rates will increase their profits this year, despite the turmoil elsewhere. Ana Botin, executive chairman of Banco Santander, said: “Our 2022 results have been a record, with a very different year than was expected.”

“It’s still difficult for the economy; it’s not clear what’s going to happen, but we feel confident with the guidance we’ve given,” he added.