EU Banking Outlook
On Track for Solid Performance Despite Rate Cuts
A recent Morningstar DBRS commentary states that European banking sector is poised to maintain solid performance in 2025 despite the anticipated decline in net interest income (NII) due to projected interest rate cuts. This follows a period of strong earnings and positive credit ratings in 2024, driven by strategic cost management and robust net interest margins. While profitability is expected to dip, banks are projected to remain resilient, supported by stronger loan growth, steady fee income, and controlled credit costs.
Performance Insights for 2024
Throughout 2024, European banks sustained high profitability levels, with an average return on equity (ROE) of 11.1% in the first half, maintaining a year-over-year consistency and marking an improvement over previous years. This was fueled by stable NII and a notable 8% increase in fee-based income. Cost pressures persisted due to wage inflation and investment needs, but overall risk costs remained consistent, showcasing the sector's solid asset quality.
2025 Expectations: A Shift in Earnings Dynamics
In 2025, as European interest rates decrease, banks are expected to see a reduction in NII, which constitutes over 70% of their core revenue. The European Central Bank’s previous measures, such as ending remuneration on minimum reserves, have already exerted pressure on margins. This, coupled with increased deposit costs and slower asset repricing, points to a trend of declining NIM. However, loan growth is expected to offset some of this pressure, driven by improved economic conditions and rising mortgage activity as property prices stabilize.
Asset Quality and Credit Cost Outlook
Asset quality across European banks is anticipated to deteriorate slightly due to the ongoing challenges in specific corporate sectors. Nonetheless, improved economic conditions and wage growth will likely cushion the impact. The credit cost landscape is predicted to remain broadly stable, supported by the release of loan loss provisions set during prior economic uncertainties. Notably, banks will need to manage the potential rise in non-performing loans (NPLs), especially in commercial real estate and regions more reliant on the automotive sector.
Structural and Regional Variations
Profitability and risk exposure will continue to vary by country, with Southern European economies benefiting from strong service sectors and support from the EU’s Recovery and Resilience Plan. Conversely, nations like Germany may face more pronounced challenges due to their industrial exposure and a competitive disadvantage in energy costs.
Regulatory Developments and Capital Positioning
2025 marks the beginning of the final phase of Basel III (referred to as Basel IV), though its complete implementation will span until 2032. These changes, including new output floors to standardize capital requirements, are expected to have a gradual impact. European banks, having built robust capital buffers, are projected to navigate these regulatory changes effectively
Strategic Outlook and Sector Consolidation
Amid pressure on revenues, the sector could witness more consolidation activities, though large-scale cross-border mergers will likely remain exceptions due to differing regulatory and operational environments. Instead, targeted partnerships and smaller acquisitions are expected to dominate the M&A landscape
Conclusion
While European banks face a year of adjusted profitability due to decreasing interest rates, they are positioned to endure these shifts with stability. The sector's focus on diversified revenue streams, cost control, and strategic adaptations will be key to sustaining resilience through 2025 and beyond.
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Relevant Links:
https://dbrs.morningstar.com/research/442859
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