9th July 2019

Profitability challenges the banking sector, according to EBA Risk Dashboard

The European Banking Authority (EBA) has published its Risk Dashboard, which summarises the main risks and vulnerabilities in the EU/EEA banking sector. The Risk Dashboard includes, for the first time, IFRS 9-related data on asset quality and banks' fair valued positions, as well as information about their sovereign exposures. Together with the Risk Dashboard, the EBA published the results of its Risk Assessment Questionnaire (RAQ), which includes banks' and market analysts' expectations for future trends and developments.

European banks' CET1 ratios – both fully loaded and transitional – remained unchanged during the first quarter of the year, standing at 14.5 per cent and 14.7 per cent, respectively. Along with the capital components (CET1, numerator), the risk exposures amounts (REAs, denominator) rose at a similar pace, reflecting an increase in total loan volumes.

The quality of EU/EEA banks' loan portfolio has improved further, albeit at a slower pace than in previous years. In Q1 2019, the ratio of non-performing loans (NPLs) to total loans declined to 3.1 per cent (3.2 per cent in Q4 2018 and 3.8 per cent in Q1 2018). A small increase of EUR 4bn in the NPLs, due to one-off events, was more than offset by the rise of EUR 700bn in total loan volumes (denominator). Similar to the contraction of the NPL ratio, also the share of stage 2 (7.2 per cent of total loans) and of stage 3 (3.6 per cent) loans have declined during recent quarters, including Q1 2019.

According to the responses to the RAQ, banks plan to further expand their corporate lending, especially in the SME segment, and their household exposures through both, mortgages and consumer lending. Almost half of the banks aim to fund their growth by increasing MREL liabilities and retail deposits. Nonetheless, banks and analysts are now more pessimistic in respect of future trends in asset quality. Respondents are particularly concerned about the possible deterioration of corporate and commercial real estate exposures.

Profitability of EU/EEA banks has not improved and remains a key challenge for the sector. The average return on equity (RoE) stood at 6.8 per cent, similar to the same quarter last year. Cost inflation weighed on banks' cost to income ratio (CIR) as it reached its highest level since December 2014 (66.3 per cent, up from 65 per cent a year earlier). On the contrary, banks' net interest margin (NIM) tightened further in the first quarter to 1.42 per cent, its lowest level since December 2014.

Banks expect profitability to remain subdued, with only about 25 per cent expecting an improvement in the next 6-12 months. Almost 50 per cent of banks participating in the RAQ suggest their current earnings do not cover their cost of equity (CoE). The latter is estimated by the banks in a range of 8 per cent-10 per cent. In order to improve their net income, banks mainly aim to reduce their operating costs and to diversify their income streams by increasing fees and commissions through asset management and payment services.