September 4, 2019/Fitch Ratings
The European banking sector’s revenue outlook has weakened since the start of 2019, with accommodative monetary policy likely to continue squeezing banks’ margins, Fitch Ratings says in a new quarterly report. Banks’ revenue could face extra pressure as a result of the uncertain operating environment, notably from risks linked to Brexit, eurozone politics and the US-China trade war. However, most banks still have significant scope to improve cost-efficiency to support earnings, and we do not expect significant asset-quality deterioration in the short-term.
Revenue weakness was a theme in the sector’s 1H19 results, as we had expected, and several banks lowered their earnings targets, citing the challenging and increasingly uncertain operating environment. Recent announcements by central banks indicate that interest rates are likely to remain low across the region in the medium term, weighing on net interest margins. Competitive pressure and lack of pricing discipline are exacerbating this in some countries. The outlook for sales and trading income is also weak because of macro-economic uncertainty and subdued capital markets activities in the context of a secular decline in the global fee pool.
The depressed revenue outlook is likely to increase banks’ focus on improving cost efficiency to support their profitability. Many banks have yet to address long-standing structural cost-inefficiencies that were masked by top-line revenue growth in recent years. The median cost/income ratio for the 20 large European banks analysed in our report was 66% in 1H19, which is high enough to suggest that there is significant scope for improvement. We expect banks to accelerate cost-cutting through branch closures and staff reductions, and the sale or closure of non-core businesses. In addition, we expect increasing emphasis on digitalisation to improve cost efficiency.
We expect the sector’s asset quality to remain stable in 2H19 as low interest rates continue to support borrowers’ ability to service debt. Europe’s economic slowdown has not yet resulted in a material increase in newly impaired loans. Loan impairment charges remain moderate overall, despite having risen from cyclical lows, and banks in countries with higher non-performing loans are still reducing their stocks of problem assets, though at a slowing pace. However, the weakened economic outlook increases the likelihood of at least a modest deterioration in asset quality in the medium term, particularly given the high levels of private sector debt.