Daily Times

European banks may have managed to generate surprisingly solid earnings in the second quarter, but low interest rates, Brexit fears and trade war woes make a repeat performance unlikely, analysts say.

Big names BNP Paribas, Barclays, Intesa Sanpaolo, Credit Suisse and BBVA all wrongfooted sector experts with results exceeding consensus forecasts.

“For many banks, earnings were better than expected,” Simon Outin, an analyst with Allianz Global Investors, told AFP.

“But it’s also true that consensus forecasts had been lowered quite a bit recently,” he said, as banks were seen struggling to thrive in their traditional credit business.

That they still managed to pull off an earnings surprise was mostly down to view that loan repayment rates are improving, justifying a reduction in funds set aside to cover risky exposure, and giving the bottom line an immediate boost.

Banking on lower risk

“The main adjustment variable for almost all the banks which have reported earnings are the provisions against doubtful loans which are much lower than expected,” said Jerome Legras, head of research at asset managers Axiom AI. “This in essence was what made the results better than analysts’ expectations,” he told AFP.

Taking back risk provisions helped banks offset the dampening impact of a low-interest rate environment that is set to linger even as EU growth and inflation are showing signs of picking up.

French bank Societe Generale said it expects to improve its risk management further throughout the year, a hint that it could take back more provisions to feed profits.

In southern Europe, Spain’s BBVA and CaixaBank, Portugal’s Caixa Geral de Depositos and Italy’s Intesa SaoPaolo are all making progress in removing toxic loans from their books.

Even the world’s oldest bank, Monte Dei Paschi Di Siena, managed to eke out a profit in the three months to June, a remarkable performance given that the bank was so weakened by the 2008 financial crisis that it was pulled back from the brink with a government bailout.

Don’t push it

But while analysts accept that taking back risk provision is a legitimate reward for improved risk management, they also say that banks shouldn’t push their luck.

Some, like Dutch banking giant ING, are “playing with fire” with their low provisions, said Martin Crum, an analyst with IEX.nl.

“You can’t reduce the cost of risk indefinitely,” added Legras at Axiom. “At some point it will reach the bottom of the cycle and then you will need other sources of growth, either from greater cost control, or from improving interest rate margins.”

But those margins are difficult to boost while official interest rates remain low, analysts warned, meaning banks can’t make much profit from loans.

The eurozone institution able to do something about that, the European Central Bank, has not shown any signs of wanting to hike official rates any time soon despite moving its quantitative easing stimulus policy slowly towards the exit.

Aiming for corporate

The EU’s other big central bank, the Bank of England, raised its key rate at the start of August, but also hinted that interest rates wouldn’t rise again soon.

Instead, Europe’s retail banks try to use the improving economy to bolster their loan volumes, especially in the corporate sector which is poised to invest in the budding economic recovery.

But that strategy has become more uncertain as trade risks and political worries threaten to throw a spanner in the works.

Swiss banking group UBS has warned that rising protectionism was puncturing investor confidence, and Credit Suisse said upcoming monetary policy shifts by the world’s central banks were likely to sow uncertainty.

Meanwhile, Britain’s looming departure from the EU is a big headache for that country’s banks just as they have recovered a high level of financial strength.

For them, the stakes in Brexit talks are especially high because of the question of what will happen to passporting rights, which allow EU members to do business in each other’s countries without needing further authorisation.

Published in Daily Times, August 6^th 2018.