European banking sector outlook 2023

On April 26, Markus Schmaus, a senior director at S&P Global Ratings in charge of bank credit coverage in the DACH, Nordics and CEE regions, spoke about expectations for European bank performance and potential risks following the market turmoil in March.

Here are the key takeaways from the presentation:

• Sector resilience: European banks overall are well positioned to tackle the more challenging economic and market environment. Their well-diversified portfolios and sources of funding differentiate them from the recently collapsed US regional banks. Credit Suisse was a clear outlier among major European banks and the risk for a wider sector contagion is low despite the current lack of market confidence. Currently, the rating bias on European bank ratings is slightly positive and the share of rated banks with "negative" outlook has been declining over the last four quarters.
  
  
• Fallout from market turmoil: The shocks of the US bank failures and Credit Suisse's state-brokered merger with UBS has alerted the market to stability and liquidity risks in the banking sector. Most affected by the shift in market sentiment would be specialized banks, private banks and others with excess liquidity, investment banks as well as credit institutions that are already under some stress. Among the potential reactions to this shift could be the expansion in issuance of secured liabilities and the delay of issuance of Additional Tier 1 (AT1) securities, which were a cause for controversy in the Credit Suisse-UBS merger.
  
  
• Low risk of unrealized bond losses: This type of losses is not considered a systemic risk for European banks because of their strong capitalization. Bond losses are realized in earnings and capital, or just capital, and the sector capital ratios were at a high level, of 15% as of Sept. 30, 2022.
  
  
• Key loan book vulnerabilities: Based on their lending mix, European banks are at most risk of asset quality deterioration in unsecured consumer, SME and commercial real estate loans. The cost-of-living crisis could affect retail borrowers to repay loans and SME loans could also suffer as consumer demand weakens. CRE loans are at risk due to the tightening funding conditions.
  
  
• Downside risks in 2023: Higher interest rates, prolonged recession, persistent inflation and further market volatility remain key risks for European banks this year. Despite the sector's resilience, the seismic shift in monetary policy could still put pressure on many institutions, especially if deposit repricing and funding costs rise faster than expected. Higher rates also have the potential to destabilize the wider financial system as they affect leverage and liquidity in the non-bank financial sector. On the macro side, a protracted recession could lead to asset quality deterioration, while longer-lasting core inflation would increase operating costs.

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