German banks are on average better capitalized and better capable of absorbing long-term credit losses than Western European peers, but they are less profitable and efficient, according to S&P Global Ratings.
Several years of restructuring and de-risking across the sector, declining loan loss provisions helped by the strong economy and increased regulatory pressure have driven up the average capitalization at German credit institutions, the rating agency said in a Dec. 18 research note.
The average risk-adjusted capital ratio, weighted by total assets, of the 14 German banks for which S&P Global calculates the ratio stood at 10.8% as of 2017-end, above the average ratio of 9.7% measured at the 50 largest European banks rated by the agency.
The ratio at 11 of the 14 rated German banks was above 10% and two of the institutions even showed ratios of above 15%, the credit analysts said. Furthermore, the German banks' long-term loss absorption capacity is generally strong when compared to Western European peers as many of the institutions, especially smaller, specialized banks, have high earnings buffers to absorb future credit losses.
Where German banks still lack momentum is in profitability, which remains below the European average due to the strong dependence on net interest income which has been a serious drag to earnings given the low-interest rate environment in Europe in recent years.
In 2017, German banks' profitability was an average of 1 percentage point lower than peers in Western Europe, S&P found.
Nevertheless, there is a glimmer of hope for the coming years, as German banks have managed to raise the share of their fee income and when interest rates rise again this is set to boost profits, according to the report.
Having maintained low rates as an economic stimulus after the global financial crisis, the European Central Bank has now started a gradual normalization of monetary policy and is expected to announce its first rate hike in the second half of 2019.
Another problem area that weighs on German banks' profit-generating capacity is the high ratio of noninterest expenses to operating revenues. The average ratio for the German banks was 64% in 2017, well above the average ratio of 48% for the 50 largest European banks. The lower-than-average efficiency stems from high restructuring costs as well as the additional need for IT infrastructure improvements, S&P said.
German banks' capitalization is expected to remain robust in the next 24 months but is not likely to give much impetus for future rating upgrades, S&P said.
"Furthermore, if the German economy were to experience an unexpected shock, resulting in increased credit losses and deteriorating business activities, we would expect this to weigh on the banks' ratings", the agency said.
Key credit risks for German banks are their corporate and retail loan books, S&P said.
This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global. Please click here to read the full report of S&P Global Ratings.