European banks have been resilient in the face of the economic downturn created by Covid-19. As economies normalise, risk shifts to the withdrawal of fiscal, monetary and regulatory support and to pre-crisis weaknesses such as core profitability.
As vaccination rates increase and countries move towards achieving herd immunity, the market debate will shift to the sustainability of the economic rebound. An important element of that will be how quickly accounting and supervisory relief granted to banks normalises.
“Asset quality will deteriorate, but concerns over cliff effects are misplaced. Authorities will err on the side of caution when tightening their regulatory stance, and most banks will be able to absorb high credit costs through pre-provision profits. The asynchronous nature of the recovery could continue to create supply bottlenecks, however, which may result in asset-quality hotspots.”Dierk Brandenburg, co-head of Scope’s financial institutions team
Rising inflation could signal an eventual change to a monetary policy regime that for many years has burdened the banking sector with negative rates and flat yield curves. But while there may be a ray of light at the end of the tunnel, Scope expects regulators to resume the path towards higher capital requirements in line with previously agreed targets. Without decisive restructuring, many banks will be unable to clear their cost of equity even under a more supportive rate environment.
“Banks will release trapped capital as earnings visibility improves. Supervisors will allow them to reinstate dividends and buybacks provided they can ease concerns over credit losses. As there are significant regional differences in the loss experience, we expect supervisory authorities to adopt a differentiated approach to dividend policies, backed by safeguards such as stress testing.”Marco Troiano, co-head of Scope’s financial institutions team
Cost cutting and M&A will continue to characterise the sector in 2021 and beyond. Faced with rising penetration of digital channels and the emergence of non-bank competitors, banks are striving to accelerate technology investment while reducing physical distribution costs to protect market share and profitability. Domestic M&A as well as integration of new technology providers will allow for economies of scale in IT investments.