European Banking assesment

The European banking Authority (EBA) released its annual risk assessment of the European banking system which provides detailed information, in a comparable and accessible format, for 120 banks across 25 EEA / EU countries.

Overview of key EBA´s risk assessment report findings:

• Banks’ capital and liquidity positions have further improved: The average fully loaded Common Equity Tier 1 ratio has increased up to 15.5% in the second quarter of 2021 (from 14.7% in the same quarter of 2020). The report states that “although supervisory recommendations on capital distribution have expired, banks should not pursue overly generous dividend and share buy-back policies”. The positive mood in funding markets and the availability of central bank funding allow banks to maintain comfortable liquidity positions. The average liquidity coverage ratio is at 174.5%.
• Asset quality has improved overall: The average NPL ratio decreased from 2.9% in the second quarter of 2020 to 2.3% in the same quarter of 2021. Fears about potential asset quality deterioration have not materialized, except for the sectors most affected by the pandemic. However, the report points out to three sources of potential concern going forward:

- Uncertainty on the economic outlook. For example, potential deterioration of economic outlook due to the pandemic or rising rates due to inflationary pressures.

- Loans under public guarantee schemes and under moratoria as an increasing share of these loans are being classified under stage 2 or as NPL. 

- Real Estate. Accelerating house price increases along with banks’ recent focus on residential mortgage lending may become a source of vulnerability going forward. Also, commercial real estate (CREs) may pose even more challenges for the banks, as they remain vulnerable to structural changes in the post pandemic era. 

• Profitability improvement due to lower impairment costs: 

- The average Return on Equity (RoE) stood at 7.4% as of June 2021 (from 0.4% a year before) is still below the estimated cost of equity (CoE). Only half of the banks responding that their RoE was above their estimated CoE (estimated >8% for three quarters of the respondents). Banks’ net operating income has not recovered to pre-pandemic levels.

- Despite the RoE improvement, structural challenges, such as low or negative interest rates and fintech and big tech competition remain.

- Poor profitability is also reflected in low market valuations, listed European banks are still trading below their book values (o.6x for European banks vs 1.6x for US banks).