Grand Duchy banks are taking action to prepare for an economic downturn, according to bank sector association ABBL.
At its annual general meeting on Thursday, the organisation noted that rising interest rates and geopolitical uncertainty have caused households and companies to become reluctant investors. Banks began setting aside more provisions last year in order to cover increased risk of credit defaults - a move already reflected in 2022 figures with an increase of over 400%.
Bank sector provisions stood at 9 percent of the at the end of last year, or 1.29 billion euro, compared to 2 percent, or 257 million, a year earlier.
ABBL said nevertheless that its officials do not foresee a collapse of the Luxembourg real estate sector, nor a credit crisis. Luxembourg’s default rate - 1.6 percent as per end 2022 - remained well below the European average of 2.6 per cent. In recent months though, housing markets in Luxembourg have begun to experience a drop in demand.
Overall bank sector profits last year were up 2 percent, supported by an increase of 39 percent in income from interest. “Our sector has shown its resilience,” said ABBL chairman Guy Hoffmann, before defending the higher interest rates that banks charge. Commercial bank rates have risen in anticipation of further hikes in key benchmark rates set by the European Central Bank.
Declining purchasing power
Speaking at a press event, Hoffman also referred to the pressure that many people face from rising costs of living, with inflation eating into purchasing power.
“Much has been said and written about the interest rate hike decided by the European Central Bank to combat inflation,” Hoffman said. “We fully understand the questions it raises among our fellow citizens who are already facing a drop in their purchasing power. But it is clear that the current rates, and consequently the interest income earned by banks, are only in line with their historical average.”
“War in Ukraine, tensions and conflicts in more distant regions, natural disasters increasingly palpable, even in our regions, make people worry about their future. At the same time, difficulties in Switzerland, but also questions about a potential real estate crisis in our country,” he said.
The role of banks and other financial services - employing some 65,000 people - is a particularly important aspect of Luxembourg’s economy, which depends for 26 percent on the financial sector. Although the per-capita GDP in Luxembourg is the highest in the world - at 129,000 dollars per year - national media this week reported Luxembourg’s workers also are most at risk of poverty in the eurozone. Almost one in seven workers - 13.5 percent - is at risk of poverty in Luxembourg, compared to a eurozone average of 8.9 percent.
23 Luxembourg banks remain unprofitable
Although the banking sector as a whole is seen as solid, 23 of Luxembourg’s 121 financial institutions last year remained unprofitable. The country’s financial supervisor CSSF at the end of March said that at the end of 2022, 23 banks had a costs-income ratio bigger than 100 percent. The average costs-income ratio for Luxembourg banks was 56 percent last year, below the 60 percent reported for the end of 2021. “This average reflects significant disparities between banks,” CSSF said on 27 March.
Further consolidation is expected in Luxembourg’s banking sector, said ABBL, after the number of banks declined to 121 from 124 a year earlier. Many of the smaller banks in the grand duchy are unable to deal with increasingly stringent requirements for anti-money laundering and sustainable finance, at a time that they are also required to make major investments in IT systems and improving cyber security.
“The concentration movements that began a decade ago are expected to continue,” ABBL said. “The decline in profitability of European banks in general is not unrelated to this phenomenon. The challenges to earnings remain numerous, mainly due to the cost of compliance, heavy investments in digital and sustainable transformation, and the need to maintain a high level of customer service, and rising overheads.”
‘Matter of public interest’
The issue of bank profitability is a matter of public interest, ABBL said. “To ensure their important role In order to play their important role in society, banks need to be stable. And for them to be stable, they must also be profitable,” said Hoffmann, adding that sound capitalisation enables banks to finance households and companies by granting them loans while better resisting shocks.
The number of jobs in the banking sector remained stable at around 26,000 employees. ABBL CEO Jerry Grbic said the sector is facing the same challenges as the rest of the private sector when it comes to attracting new talent. “The sustainable growth of banks depends on their ability to exploit the opportunities of the digital and sustainable transition, to manage and sustainable transition, to manage risk globally, and ultimately to continue to provide the quality of service that our customers have a right to expect,” he said.