“The real test for banks is yet to come”
Three questions for Dr. Dirk Holländer, Senior Partner
The stock markets are celebrating new highs. The performance of bank shares, however, is disproportionately poor. What were the reasons in 2020 and what is the outlook for 2021 – or put simply: how are European banks doing? Dirk Holländer, Senior Partner and Managing Director of zeb in the UK, answers these questions in our short interview.
COVID-19, global GDP down by over four percent, an impending wave of insolvencies – the past year was difficult in many respects. Looking at banks, how deep will the cracks be in their balance sheets and P&L statements?
Overall, banks were an important part of the economic rescue team in the past year. In this role, they made an important contribution with and for their customers. Despite the associated burdens, many large European banks remain stable in terms of their capitalization. We expect capital ratios at the end of 2020 to remain good on average and even to increase slightly overall. In addition, many banks have significantly increased their already high liquidity buffers in response to the crisis and the uncertainty it entailed.
Profitability remains the real problem for many large European banks. Profits have already been low in recent years, which we have presented in our European Banking Study time and again. The crisis year 2020 exacerbated this situation. While the return on equity of the 50 largest banks in Europe still averaged 6.4 percent in 2019, it more than halved in the wake of the pandemic to 3 percent in 2020, according to our estimates.
Overall, we expect about 10 to 15 of the 50 major European institutions to report losses. Only about a handful of banks will manage to come close to their 2019 results. The majority will at least be able to report a profit – albeit a significantly reduced one in some cases.
What is the reason for the significantly lower results for 2020?
At the beginning of the crisis, there were fears about potential negative effects on earnings and costs in the pandemic. In retrospect, however, the major European banks have been able to manage these. In some cases, there were even positive effects: asset and wealth management, and investment banking in particular – for many years a problem area for some institutions – benefited significantly from greater uncertainty and the associated market volatility. In addition, volumes in the lending business rose sharply.
Operating costs were stabilized and even reduced by making some tough cuts, such as reducing external variable costs or postponing larger projects until 2021.
However, what is having an impact are the skyrocketing costs of risk. After the first six months of 2020, loan loss provisions – as a percentage of average total assets – already exceeded the previous year’s figure.
We expect risk provisions to normalize overall in the last two quarters of 2020. Still, they are expected to be more than twice as much for the full year as they were in 2019. But: the peak levels of risk provisioning in the years following the global financial crisis should not be reached.
Let’s look ahead. What does 2021 hold for European banks?
In terms of profitability, the crisis has revealed the core problem of many institutions. The increased profits of the past few years have essentially not been generated by operational business, but by reducing loan loss provisions. Banks have benefited from a steadily improving credit environment in recent years since the end of the European sovereign debt crisis.
And now many banks are faced with having to deal with increasingly non-performing loans in their portfolio and at the same time are forced to take operational measures, usually further cost reductions or adjustments in pricing policy.
Additionally, starting in the second half of 2021, the real test of bank resilience is yet to come, as our preview of the status quo analysis of the European Banking Study 2021 has just shown. Following the expiry of moratoria and state aid, an increase in insolvency figures is to be expected – with possible negative effects on the P&L statement if the risk provisions created to date are not sufficient.
In addition, expected rating deteriorations in corporate banking could lead to an inflation of risk-weighted assets – and thus to decreasing capital ratios. So although we can cautiously hope for ways out of the pandemic in many areas, some effects will hit banks downstream.
Developments to date give reason to hope that the overall banking sector will be able to cope with this burden. However, the real test is yet to come this year.