In December 2023, the European Central Bank (ECB) cautioned lenders in the Eurozone of widespread fluctuations in funding sources in 2024. This comes in light of worsening geopolitical risks and heightened uncertainty within the banking sector. However, the ECB acknowledged the sector’s resilience in 2023, attributing it to robust capital and substantial profits.
Strong profit growth
Throughout 2023, Eurozone banks continued to experience strong profit growth due to interest margins, achieving the highest levels of profitability in over a decade. This increase in profitability was particularly pronounced in countries where variable rate lending predominated, and the adjustment of higher interest rates to deposit costs was more gradual.
This increased profitability allowed European banks to distribute around $70 billion in bonuses to investors.
Furthermore, European banks successfully navigated a challenging stress test conducted by the European Banking Authority. The higher profits and improved asset quality at the outset of 2023 contributed to bolstering moderate capital in adverse scenarios. The authority asserted that, despite cumulative losses amounting to $496 billion, EU banks maintained sufficient capital to sustain economic support during periods of extreme stress.
Andrea Enria, the chair of the ECB supervisory board, stated that European banks had shown significant profitability and were contemplating dividends in line with previous years. Enria considered the figures to be “highly provisional and preliminary.” Consequently, the ECB is assessing whether these payments align with the banks’ capital trajectories.
Despite this positive outlook, the ECB believes that banks will increasingly experience the adverse effects of rising interest rates. Moreover, tightening financing conditions and the rising cost of living are expected to negatively impact borrowers’ ability to service debts.
The ECB posits that a period of rising interest rates could yield long-term benefits for the stability of the financial system. However, it acknowledges the potential for temporary increases in market volatility.
It is worth noting that the ECB, in its last meeting in December, maintained its key interest rate at a record high. It asserted its commitment to keeping it there for as long as necessary to combat inflation. Consequently, despite expectations of changes in 2024 to support the contracting economy, interest rate cuts are not imminent. The ECB provided limited information about its future actions following the retention of the benchmark interest rate at 4 percent.
Banks’ non-performing loan ratios remained relatively stable, hovering just above 2 percent in the first half of 2023, according to ECB statistics. Nevertheless, emerging signs of increasing losses have surfaced in select loan portfolios sensitive to economic downturns. Default rates for both corporate and retail liabilities have started to climb, signaling potential growth in non-performing loans.
The Eurozone economy is expected to experience modest growth of 1.3 percent in 2024. Amid uncertainties surrounding the possibility of the ECB reducing interest rates, questions arise, including the outlook for European banks in 2024.
In its report, Fitch Ratings believes that major European banks will start 2024 from a position of strength. They will navigate through subdued economic expectations following their strong performance in 2023. The better-than-expected asset quality performance in the first nine months of 2023, despite a decline in lending volume, positions banks well to confront potential deterioration in 2024.
Fitch‘s forecasts are based on the premise of European banks maintaining substantial capital reserves. However, intensified competition for deposit bonuses has prompted certain banks to raise their offers on term deposits. This leads to higher funding costs in the first quarter of 2024.
Fitch expects a moderate decline in asset quality in 2024 unless there is a sharp increase in unemployment. Moreover, non-performing loans are expected to rise in tandem with an increase in insolvencies and weakened repayment capacities.
The EU banking lobby faces a particularly uncomfortable decision as it weighs the possibility of engaging in a conflict over the bloc’s banking bonus cap. The European Union implemented a bonus cap for “material risk takers” in 2014 in response to public outrage following the financial crisis. However, U.K. officials are now advocating for the abandonment of this cap to enhance post-Brexit Britain’s appeal as a financial center.
At that time, a maximum bonus limit was established for certain bankers engaged in financial services within Europe. The cap was initially set at 100 percent of the salaries of financial risk-takers and their managers. However, it later increased to 200 percent with shareholder approval.
Some perceive the cap’s impact as creating an uneven playing field in the financial sector. Hence, it allows British, U.S., and other foreign banks to leverage unlimited bonuses for attracting and retaining top talent. In contrast, European banks such as BNP Paribas and Deutsche Bank need to maintain a ceiling for variable wages at twice the salary.
Deutsche Bank’s Christian Sewing, speaking at the recent Financial Times Global Banking Summit, emphasized that if the cap was lifted elsewhere, the EU needed to consider this factor and strategize on how to remain competitive.
Despite the overall profitability of banks, both globally and in Europe, substantial layoffs occurred in 2023. It marked one of the most significant years for job cuts since the 2008 global financial crisis. The historical reduction in interest rates by European banks in 2015 and 2019 contributed to widespread layoffs within the banking sector.
Global banks collectively laid off over 62,000 employees in 2023, accompanied by a decline in new hires. That was a trend exacerbated by the emergence of the COVID-19 pandemic. Financial Times calculations predict that the 20 largest banks globally will terminate at least 61,905 employees in 2023. That includes those affected by UBS, a stark contrast to the 140,000+ job cuts during the 2007-2008 financial crisis.
For instance, in Switzerland, UBS’s acquisition of Credit Suisse resulted in the latter cutting a minimum of 13,000 jobs. Furthermore, anticipation for further rounds of layoffs in 2024 positions it as one of the largest workforce reductions by a single institution.
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