Major European banks’ longer-term earnings prospects after the coronavirus crisis will depend on how effectively they can tackle structural challenges that predate the pandemic, Fitch Ratings says. Earnings will continue to be pressured by low interest rates, competition and the need to invest in digitalisation to build leaner business models.
The 20 large European banks covered in Fitch’s latest Quarterly Credit Tracker should benefit from a rebound in economic growth in 2021-2022, helped by their established franchises in core markets and strong fee-intensive businesses.
However, their net interest margins (NIMs), which were still generally below pre-pandemic levels in 1Q21, will continue to face pressure from low interest rates and fierce competition. We expect only a modest increase in NIMs in 2021 given this pressure, the low yields on state-guaranteed loans issued during the pandemic, and the time it will take for unsecured loan portfolios to recover towards pre-pandemic levels.
The 20 banks reported a sharp increase in revenue in 1Q21. Strong capital markets activity and corporate and investment banking drove earnings for many of the banks and may continue to do so as retail and commercial banking revenues are likely to remain below pre-pandemic levels in 2021.
Fitch estimates that the banks’ median return on equity was about 8% and the median annualised operating profit/risk-weighted assets ratio was 2.1%, compared with 0.9% in 1Q20 and 1.7% in 2019. We expect that the banks’ 2021 operating performance will be broadly in line with 1Q21, subject to the pace of potential provision reversals, which could support some banks’ profitability.
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Most eurozone banks are benefitting from ultra-cheap funding from the ECB’s targeted longer-term refinancing operations. This has helped to mitigate the impact of low interest rates and customer deposit inflows on their NIMs.
Cost/income ratios are gradually benefitting from better cost control, with the median ratio improving to 64% in 1Q21 from 70% in 2019. We expect cost efficiency to continue improving, helped by restructuring initiatives to deliver more efficient and innovative business models.
Banks are likely to focus on reducing their branch networks, investing in digital payment services and seeking ways to generate additional fee income, notably through savings management services and financial advice.
We recently lowered our forecasts for western European banks’ loan impairment charges (LICs) in 2021, reflecting better-than-anticipated economic conditions (see Western European Banks’ Prospects for 2021 Better than Expected). Some banks partially released Stage 2 loan impairments and management overlays in 1Q21, and others are likely to follow later in the year if vaccine rollouts and the economic recovery continue favourably. This could temporarily support profitability, particularly for those banks that strongly front-loaded their provisions in 2020.
However, while LICs for most large European banks are likely to be lower in 2021 than in 2020, we expect they will still be above pre-pandemic levels, reflecting moderate risks to asset quality as measures to support the economy and borrowers are withdrawn.
Of the 20 banks, 10 have ratings on Negative Outlook, signalling continued risks to ratings in the medium term. Nine have ratings on Stable Outlook, and one, Deutsche Bank, has its rating on Positive Outlook, which reflects progress with its restructuring plan.
