The European banking sector has witnessed a remarkable resurgence, chalking up its best performance since the 2007 financial crisis, according to a recent Deutsche Bank research report. Notably, European banks have narrowed the long-standing performance gap with their US peers.
A confluence of factors has underpinned this revival. Rising interest rates, for instance, spurred a 20 percent year-over-year jump in net interest income, which now accounts for a whopping 56 percent of total revenues. The significance of interest rate normalisation for European banks cannot be overstated, said Jan Schilbach, head of the banking team at Deutsche Bank Research in Frankfurt.
“The biggest driver at the 22 major institutions, a proxy for the whole industry, was the 20 percent yoy jump in net interest income,” Schilbach said in a note to investors. ”The second-largest component, fee and commission income, remains sluggish, falling 3 percent yoy during the first half of this year.”
Yet, it’s not all smooth sailing. French banks grapple with domestic retail business challenges, particularly due to unique characteristics of the popular Livret A deposit accounts. In the domestic retail business, the upside on the income side is limited as they face quickly rising funding costs due to the peculiarities of the popular Livret A deposit accounts, while mortgages are mostly fixed-rate.
On the brighter side, the often unpredictable trading income surged by 85 percent. All things considered, the sector witnessed a 14 percent rise in revenues.
Cost discipline
The strong revenue performance was paired with commendable cost discipline, the research team at Deutsche concluded. Despite inflationary pressures, administrative expenses saw a mere 3 percent increase. Some banks even reported a decline. Furthermore, despite economic headwinds, European banks managed to maintain stellar asset quality. Consequently, net income skyrocketed 57 percent from the prior-year figure, touching an unprecedented 74 billion euro.
In terms of Return on Equity (ROE), the majority of banks boasted double-digit post-tax ROE figures, with the unweighted average surging by 5 percentage points to 13 percent. It’s worth noting that such figures haven’t been seen since the 2007 high-water mark. Also, the cost-income ratio saw a substantial 6 percentage point decline, settling at 52 percent.
Moving to the balance sheet, while there was a slowdown in loan growth and repayments of ECB funding, the CET1 ratio and leverage ratio both saw annual increments, signalling robust capital and liquidity levels. The Liquidity Coverage Ratio stood at 152 percent, even as banks began transitioning away from the central bank funding provided during the pandemic.
Levelling with US peers
But how do European banks stack up against their American counterparts?
US banks have historically outperformed their European peers. However, the present profitability ratios indicate that European banks have successfully closed this gap, a feat unseen since 2015. While US banks saw a net interest income rise of 21 percent in the first half of the year, the increase in loan loss provisions was a hefty 160 percent. Nevertheless, their post-tax ROE touched approximately 13½ percent, the best since 2004.
Looking ahead, there are challenges on the horizon for European banks. Rising funding costs and increasing pressure on interest margins might be potential headwinds, Deutsche said. The stronger US economy, paired with its advanced monetary policy, might mean European banks could lag again.
However, it’s undeniable: European banks are currently in a sweet spot, Deutsche argues. The shift towards a regular interest rate environment promises to have a long-lasting positive impact, ensuring that Europe’s banks remain compelling investment prospects for the foreseeable future.
Net income of Europe’s leading banks*
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