Hike funding

Funding costs and credit losses to temper high revenues in 2023 at European banks

Analysts say higher funding costs and high credit losses are expected to temper rising European bank lending revenue in 2023.

The continent’s biggest lenders enjoyed higher net interest income — income from loans less interest paid on deposits — after central banks began raising interest rates to curb inflation. Of a sample of 20 banks, 17 posted year-over-year growth in the second quarter, according to data from S&P Global Market Intelligence. UK lender Lloyds Banking Group PLC recorded the largest increase, with the NII nearly doubling year-on-year.

Net interest income is expected to continue to rise from previous years as lending volumes return to pre-pandemic levels, said Martin Rauchenwald, partner at Financial Services Capital, a specialist private equity investor based in Paris. London, at S&P Global Market Intelligence.

Lending spreads are expected to increase by 20% to 35% on average over the next three years, assuming expectations for GDP growth and monetary policy are met, said services practice director Emiliano Carchen. financial advisors from consulting firm Oliver Wyman, to S&P Global. Market knowledge. There will be a small impact on 2022 margins and a larger impact in 2023, he said.

Banco Santander SA recorded the highest net interest income in the second quarter, with the outgoing CEO José Antonio Álvarez previously said hhigher rates would provide a “large and significant increase”. Spanish and Italian banks are particularly well placed to take advantage of rising rates, Berenberg analyst Michael Christodoulou said in an Aug. 15 research note. Berenberg sees particular benefit for banks poised to benefit from higher rates, such as Spain’s CaixaBank SA.

In addition, in regions where central bank rates are rising, banks have not passed rates on to depositors as quickly as expected, Christodolou wrote.

Double edged sword

Monetary policy tightening will also lead to higher wholesale funding costs for banks, however, due to a rise in the risk-free rate and widening credit and government spreads, Elie Farah wrote, Matthew Austen and Carchen, partners of Oliver Wyman, in a recent working paper. Banks can also expect a decline in fee income over the next few years. The different business models of banks, and their varying exposure to the opposing dynamics of loan repricing and wholesale or deposit funding, as well as the structure of their balance sheets and their geographic presence, will determine the rise in their net margins of interests, Carchen said.

Higher rates are also limiting demand for loans and could lead to higher loan losses, Deutsche Bank Research analysts warned in a July 26 note.

Risk costs are already starting to rise, and will likely continue, with most of the impact expected to be seen in 2023, according to Financial Services Capital’s Rauchenwald.

“Although economic sentiment has turned negative, it will take time for the real economic impact to trickle down to loan loss provisions,” Rauchenwald said.

Twenty of the banks in the S&P Global Market Intelligence sample reported higher loan loss provisions in the second quarter or incurred charges compared to reversals a year earlier. Santander, in addition to registering the highest NII, also recorded the most provisions at 2.64 billion euros, compared to 1.78 billion euros.

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Nevertheless, banks largely increased their profits in the second quarter, with their NII offsetting high costs and loan losses, said Christodoulou de Berenberg. Thirteen of the 25 banks in Market Intelligence’s sample reported either year-over-year growth in net income or profit after the prior year’s losses in the second quarter.

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Only Credit Suisse and Societe Generale SA recorded losses during the quarter, the former suffering from its troubled investment bank and this last supported related to his exit from Russia.

Record inflation

Inflation in Europe has increased since the start of 2022 and banks are particularly vulnerable. Eurozone inflation is at a record high, reaching 8.9% in July. In the UK, inflation was 10.1% in the same month, the highest in over 40 years.

In response, the European Central Bank raised rates to zero in July for the first time in over 11 years, with another hike expected in September. The Bank of England too increased its reference rate to 1.75% early August.

European banks’ capital levels are resilient and better prepared for a downturn, according to Rauchenwald.

“The future winners will be those who can optimize their asset strategy in the emerging economic environment, with greater emphasis on underwriting and segment selection,” he said.

Banks in Russia and Ukraine, where state ownership means they are subject to different market dynamics than those in Western Europe, were excluded from this analysis.