EU banking sector: Low profits and high costs remain a key challenge: The European Banking Authority (EBA) published today its quarterly Risk Dashboard covering Q2 data, which summarises the main risks and vulnerabilities in the EU banking sector.
- Capital ratios have remained broadly stable.
- Banks‘ asset quality has further improved.
- However, low profitability keeps on being a key challenge for the sector.
EU banking sector: Low profits and high costs remain a key challenge
Fully loaded CET1 ratios remained at 14.4%, in line the previous quarters. The CET1 ratio on a transitional basis was 14.6%, 10bps below Q1, mainly as a result of one-off changes in the reporting sample. While the average capital ratios remained broadly unchanged, banks on the lower end of the distribution further increased capital ratios.
EU banking sector: Low profits and high costs remain a key challenge: here NPLs
The ratio of non-performing loans (NPLs) further declined to 3.0% from 3.1% in the previous quarter. However, while the Q1 decrease of the NPL ratio was mainly supported by an increase of total loans, the contraction in Q2 was driven by declining NPLs. Similar to the NPL ratio, also the shares of Stage 2 and Stage 3 loans declined in Q2 2019.
Return on equity (RoE) stood at 7.0%, which is 20bps above Q1 this year, but lower than one year ago. Its dispersion narrowed, with Q2 2019 being the first quarter in which the 5th percentile was above zero. Total net operating income continued its rising trend in the second quarter, supported by net interest as well as net fee and commission income. The cost to income ratio (CIR) remained high at 64.1%.
EU banking sector: Low profits and high costs remain a key challenge: here Forecast
Looking forward, rising economic and political uncertainty might negatively affect the EU banking sector. The challenge of low profitability might aggravate amid potentially increasing impairments and provisioning needs. Also new lending volumes might suffer from a worsening in the general economic conditions and from a deterioration of the asset quality.
Return on equity (RoE) has contracted – EU banking sector: Low profits and high costs remain a key challenge
It stood at 7.0%, which is 20bps lower than one year ago, and 20bps above Q1 this year. Its dispersion narrowed, with Q2 2019 being the first quarter in which the 5th percentile was
above zero. Total net operating income continued its rising trend in the second quarter, supported by net interest as well as net fee and commission income. EU banks‘ net interest margin has remained broadly stable at 1.43%, unchanged compared to one year ago and 1bp up compared to the last quarter.
The cost to income ratio (CIR) was 64.1% (63.8% one year ago, 66.3% in Q1 2019). Despite rising costs of risks on a year over year basis (Y-o-Y, from 33bps in Q2 2018 to now 47bps, 66bps in Q1 2019) the coverage ratio declined during the same period from 46.0% to 44.9% (45.1% in Q1 2019).
There have been no major changes to funding and liquidity related risk indicators of EU banks. The loan-todeposit ratio for households and non-financial corporations has continued its constantly decreasing trend to 116.4% (down from 116.8% in the previous quarter). The liquidity coverage ratio declined in Q2 (from 152.6% to 149.2%), stopping its rising trend of the previous quarters.
Liquidity and funding: EU banking sector: Low profits and high costs remain a key challenge
Banks continued to issue debt across the capital structure (secured, unsecured, MREL eligible, subordinated), except for a seasonal slowdown during summer. In recent weeks, negative yields have nearly become a new norm for covered bonds. Also among senior issuances the share of outstanding issuances with negative yield has risen. These trends affect investors’ behaviour, whose interest is moving slightly away from secured and senior instruments to subordinated ones. Additionally, investors are showing a preference for longer duration bonds to avoid negative yields.
Short-term outlook: Declining yields, spread compression and investor search for yield could favour the build-up of MREL buffers. Additionally, more banks could start to apply negative interest rates or to charge higher fees for deposits, or might strive to substitute parts of their deposits with market based funding. Negative yields might reduce investor appetite for bank debt instruments, and will increase the cost of holding high quality and liquid assets. In order to reduce these costs, banks could enhance efforts to optimise their liquidity buffers. Central bank funding, including the newly set-up TLTRO3 programme, serves as credible backstop in case of any liquidity- or funding stress.