According to the latest risk assessment of the sector by the European Banking Authority, European banks improved their capital buffers, liquidity positions and profitability in the year following the outbreak of the coronavirus pandemic.
The regulator warned, however, that banks should be prepared for a possible deterioration in the economy and for inflationary pressures that lead to rising interest rates. The EBA also raised concerns about banks that had lent to industries hardest hit by the pandemic and that were reliant on government support programs.
Banks played a pivotal role in the first year of the pandemic, serving as a “transmission mechanism” through which trillions of dollars in government and central bank aid were distributed to businesses and consumers to keep the world economy from collapsing.
While banks’ non-performing loans fell from 2.9 percent to 2.3 percent of their loan books during the year through June, the EBA warned that the proportion of non-performing loans exposed to the sectors hardest hit by the pandemic was increasing .
“The quality of the assets of loans under public guarantee schemes and moratoria is a matter of concern,” the agency said. “The accelerated rise in house prices coupled with the banks’ recent focus on mortgage loans can become a weak spot.”
At the 120 European banks monitored by the EBA, which carries out its annual risk assessment, profitability rose sharply over the course of the year from 0.4 percent to 7.4 percent.
The EBA said the increase in profitability was mainly due to the decline in bank impairments, but added that European banks’ credit margins are still under pressure due to the low and negative interest rates.
“This increases the high level of competition not only between banks, but also with fintech and big-tech companies,” said the EBA. “Despite the accelerated store closings during the pandemic, operating costs stabilized over the past year as the existing working agreements were gradually resumed.”
Banks’ capital and liquidity positions also rose during the year after the sector posted strong results in the first half of 2021 and central bank funding remained open.
However, the EBA warned that banks are offering overly generous dividend and buyback policies, despite the lifting of regulatory restrictions on shareholder returns.
“With interest rate volatility mounting, banks should carefully assess the risk profile of their funding plans and ensure that they can replace current central bank funding with other sources of funding,” added the EBA.