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As Near-Term Risks Ease, The Relentless Profitability Battle Lingers For European Banks


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As Near-Term Risks Ease, The Relentless Profitability Battle Lingers For European Banks

While we remain mindful that asset quality will weaken, easing downside risks give us more confidence in our base-case projections for European bank profitability and capitalization.   Our projections foresee the vast majority of European banks reporting improved profits in 2021 versus 2020, aided by a lower credit impairment charge (with writebacks for some), and a rebound in economic activity that could gradually improve fee and commission income (see "Economic Outlook Europe Q3 2021: The Grand Reopening", published June 24, 2021). Net interest income will remain difficult, however, with low credit growth (outside a gradual rebound in consumer credit and a general pick-up in mortgage activity) and the last turn of margin pressure for many banks as repricing of deposits and new loans becomes more evident in 2022. With regulatory capital ratios ending 2020 at all-time highs for many, and with likely low risk-weighted asset growth in 2021, the cautious restarting of dividends (for the majority) would mark a return to more normal operating conditions. Overall, European bank performance could be somewhat more buoyant, at least at a surface level, in 2021.

We reflect reducing near-term downside risks for asset quality and capitalization through the stabilization of economic risk trends.   This is the case for markets where we see the size of future rises in nonperforming assets (NPAs) as less of an issue. For now, we remain most cautious on markets where a significant element of loan forbearance ended late in the second quarter of 2021, and banks that are most exposed to borrowers in sectors that are likely to struggle most, for example commercial real estate, leisure and tourism, transport, and retail. Aided also by continued copious central bank liquidity, for many banks the risk of near-term stress has receded materially.

However, the threat of longer-term challenges persists-  whether from a yield curve that remains quite flat in the euro area in particular (despite a slight steepening in recent weeks), overbanked markets that compete away risk-based pricing, and the battle to digitize. We see the latter as a double-edged sword that offers future efficiency gains but requires both near-term and ongoing investment cost. It also brings competitive pressure from new entrants that could further commoditise banking products and erode revenues.

Beyond the Nordics and a handful of other cases, we see few Western European banks reporting return on equity much beyond mid-single-digit levels in 2022.   Even on a risk-adjusted basis, this means that returns will often remain below, or barely cover, the cost of capital (see chart 1). This impedes banks' access to capital, perpetuates the sense of a slow-moving crisis for much of the industry, and infers further restructuring and so business instability. We assume no significant rebound in 2023 or 2024 either, unless banks engage in deep transformation and process reengineering that eventually allow not only cost savings but a significant reduction in headcount and the reported cost base. For most banks, however, we assume that they will maintain flattish costs through much of this period--either because they must invest to save, or because they do not aspire to drive costs down.

Chart 1


While this is a shared burden for European banks, it presents itself differently across markets because the banks remain fundamentally national in many respects--and therefore most truly lack the scale to spread their fixed costs. Market concentration and structure varies significantly, as does flexibility of players to rapidly cut costs, and so the prospect of in-market consolidation to remove excess supply and sub-optimal cost efficiency.

The cost of capital conundrum is undoubtedly deeper for shareholder-owned banks than for the large mutual groups that dominate systems like France, Germany, and Austria.   These mutuals vary significantly but they share a stakeholder desire for stability and predictability that typically provides a mandate for gradual evolution. This might not be enough though. Covering the cost of capital is less difficult when that cost is close to zero. But sliding or stagnant operating profits undermine capacity to invest, and offer a potentially reducing capacity to absorb losses before exposing core capital. This is capital that external sources cannot replace easily.

We also note relativities with banking systems outside the region.   In particular, we see similarities between European markets such as Germany and Italy and markets like Japan and Taiwan that similarly face, to varying degrees, a risky combination of overbanking, low revenue growth prospects, weak returns, and a rising challenge to digitalize.

Mixed Rating Actions Follow These Diverging Sentiments

Until today, one-third of our ratings on the largest 100 European banks were on a negative outlook, now it's 10% (see charts 2 and 3). The negative outlooks primarily reflected doubts about the economic fallout of the pandemic on bank asset quality and capitalization. While NPAs will likely rise across Europe through end-2021 and into 2022, extensive fiscal support has undoubtedly heavily mitigated the depth of the economic shock and the associated spike in unemployment and corporate insolvencies that would otherwise have arisen. We expect the rollout of vaccines, eased restrictions on social movement and interactions, and careful withdrawal of fiscal support to sustain economic growth as 2021 progresses.

Chart 2


Chart 3


The easing in downside risks has two implications. First, it gives us more confidence in our base-case expectations that envisage, for most banks, an easing cost of risk in 2021 that they can comfortably absorb through earnings. Absent substantial writebacks, the cost of risk in 2022 could remain more elevated than before the pandemic, but is likely to be lower than in 2021 (see chart 2). While banks' regulatory and S&P Global Ratings' risk-weighted assets will typically rise during 2021 and 2022, owing to issues such as credit growth or weaker asset quality, stronger earnings resilience means less downside risk to bank capital ratios, notably our risk-adjusted capital (RAC) ratio (see chart 3). Ratios will likely start to fall by end-2021, not least because many banks will restart distributions to shareholders, but only moderately, and RAC ratios might remain above end-2019 levels for many banks.

Chart 4


Chart 5


Second, we now see a stable trend for economic risk for our banking industry country risk assessments (BICRAs) on Austria, Belgium, France, Germany, Ireland, The Netherlands, Poland, and the U.K. These systems now join banking systems in the Nordics, Switzerland, the U.S., Canada, Australia, and Hong Kong, among others, that also have a stable economic risk trend. We maintain a negative trend for economic risk on a handful of European banking systems including Italy and Spain. Here, we will observe developments in the coming months and ultimately decide whether the decline in asset quality is likely to remain within our base case.

Taken together, the easing in downside risks alleviates rating pressure for many of the banks that previously had a negative outlook.

Downgrades And Persistent Negative Outlooks Reflect Business Model Pressure

European banks are diverse in their business and operating models, and the markets in which they operate. To a degree, they face a shared challenge from digitalization, low policy rates, and shallow yield curves. However, the effects vary across markets:

  • Markets remain predominantly national, and market structure and competitive dynamics differ significantly.
  • Some lines of business and revenue streams have reasonable growth prospects, whereas others are highly sensitive to the low interest rate environment.
  • Some banks are further ahead in their digitalization journey, and competition from new entrants and the risk of commoditization is more acute in some markets than others.

Among these diverse banks and markets, we see diverging profitability trends and credit stories. Some banks will find sustained revenue growth, while others struggle to maintain their existing revenues (see chart 6). Some banks undergo deep restructuring that will yield meaningful reductions in reported costs; for others, management aims instead to simply flatten cost growth. (We cite 2022 data in this chart as it is likely to be the first relatively normal year after pandemic effects of 2020 and 2021, but in our analysis we have in mind also the following one to two years after 2022.)

Chart 6


At a system level, banks in systems like Sweden and Norway tend to benefit from relatively high market concentration, existing strong efficiency, and rapid adoption of digital technologies by customers. In systems like the U.K., Belgium, and The Netherlands, we see these factors as less compelling strengths, but nonetheless likely to provide a solid environment in which the majority of banks' business and operating models can evolve to deliver cost of capital. The profitability challenge here would be most apparent for players that lack scale or differentiated propositions that provide a source of sustainable competitive advantage. We see deeper problems in other markets, notably Germany and France--where our industry risk trend was already negative--but also Italy and Spain.

Rating actions linked to profitability and associated competitive difficulties are not new--across Europe in the past five years or so we have revised business position assessments, and occasionally BICRAs, where banks faced acute pressure. These actions included a cadre of investment banks in 2013, and, more recently, individual cases like Société Générale, HSBC, ABN AMRO, and a handful of smaller French banks. Indeed, from a methodological standpoint we do not value profitability in and of itself, but rather what this means for credit stability over the short, medium, and long-term (see Box 1).

In our latest review, we have reflected heightened competitive pressures in Germany, France, Ireland, Italy, and Spain through an adverse revision of our view of industry risk, a bank's business position assessment, or both. For Ireland, Italy and Spain, the rating effect was mitigated by an improved view of systemwide funding that recognized the banks' multi-year progress in reducing external funding dependency--a view that is not sensitive to a moderate future unwinding of current excess saving in these markets. The net result for these three markets is that the industry risk assessment is unchanged. We also now apply a negative industry risk trend to the Austrian BICRA, which means that a number of banks still have a negative outlook despite a more solid economic base case. Our view of the industry risk trend in Poland remains negative, predominantly linked to the unresolved overhang of litigation linked to legacy FX-denominated mortgage loans, but also reducing profitability in the longer term.

In view of the above, it is unsurprising that the bulk of negative actions centered on the French and German banking markets, and, within them, on banks where we hadn't already reflected restructuring, business instability, and competitive position in the ratings (see Box 2 for more detail on these markets).

Chart 7


Stable Trends Abound, So What Could Drive The Ratings Higher Or Lower?

As a result of this review, very few European BICRAs now carry positive or negative trends, and we have stable outlooks on most of the banks (see chart 8). Residual non-stable outlooks are therefore focused on a handful of banking systems, mainly linked to profitability and/or competitive positioning, and others reflect idiosyncratic developments (chart 9).

Chart 8


Chart 9


We continue to see very limited upside to European bank ratings. The positive outlooks on Barclays and Deutsche Bank reflect a potential rebound in our view of these banks. Deutsche Bank is a restructuring story that took years to come to fruition; Barclays reorganized its business some years ago, and we now see growing momentum in its franchise and creditworthiness resulting from its stable management and settled strategy. The positive outlook on Nationwide captures in part the other main upside driver--the continued building of subordinated bail-in buffers that, for some banks, may lead us to raise the issuer credit rating if we also see good peer comparability at the higher rating level.

Profitability aside, there are continued downside risks to asset quality and capitalization if the outturn is weaker than we expect. If this happened, however, the risk of a downgrade is now more likely for individual banks than for swathes of banks in certain systems. Finally, while not yet influencing our bank outlooks, we remain mindful of the side-effects of the low rate environment on asset prices, particularly in stronger economies. For example, house prices have risen sharply in the past year in countries like the U.K., Germany, Poland, Czech Republic, and The Netherlands. For now, we expect these trends to moderate, whether due to a reduction in activity or the imposition of targeted macro- and microprudential tools.


Table 1

Summary Of Changes To European BICRAs, June 24, 2021
Banking system Economic Risk / Trend Industry Risk / Trend Anchor SACP*
From To From To From To
Austria 2 / Negative 2 / Stable 3 / Stable 3 / Negative a- a-
Belgium 2 / Negative 2 / Stable 3 / Stable 3 / Stable a- a-
France 3 / Negative 3 / Stable 3 / Negative 4 / Stable bbb+ bbb+
Germany 1 / Negative 1 / Stable 3 / Negative 4 / Stable a- bbb+
Ireland§ 5 / Stable 5 / Positive 4 / Negative 4 / Negative bbb bbb
Italy§ 6 / Negative 6 / Negative 5 / Stable 5 / Stable bbb- bbb-
Netherlands 3 / Negative 3 / Stable 3 / Stable 3 / Stable bbb+ bbb+
Poland 4 / Negative 4 / Stable 5 / Negative 5 / Negative bbb bbb
Spain§ 4 / Negative 4 / Negative 4 / Stable 4 / Stable bbb bbb
U.K. 4 / Negative 4 / Stable 3 / Stable 3 / Stable bbb+ bbb+
Changes are marked in bold. *Applies to domestically-focused banks. §We revised sub-scores within the unchanged industry risk assessment. SACP--Stand-alone credit profile.

Table 2

Summary Of Rating Actions On European Banks, June 24, 2021
Entity* Long-term ICR/Outlook Group SACP
From To From To§

Bausparkasse Wuestenrot AG

BBB+/Negative BBB+/Negative bbb

Hypo NOE Landesbank fur Niederosterreich und Wien AG

A/Stable A/Stable bbb+

Hypo Tirol Bank AG

A/Negative A/Negative bbb

Hypo Vorarlberg Bank AG

A+/Negative A+/Negative bbb+

Oberbank AG

A/Negative A/Negative a-

Oberoesterreichische Landesbank AG

A+/Negative A+/Negative bbb+

Unicredit Bank Austria AG

BBB+/Negative BBB+/Negative bbb+

KBC Group NV

A-/Negative A-/Stable a
KBC Bank NV† A+/Stable A+/Stable

Belfius Bank SA/NV†

A-/Stable A-/Stable a-

Crelan SA

BBB+/Negative BBB+/Stable bbb

BNP Paribas

A+/Negative A+/Stable a


A+/Negative A/Stable a a-

Carrefour Banque

BBB/Negative BBB/Negative bb

Credit Agricole S.A.

A+/Negative A+/Stable a
Credit Mutuel A/Negative A/Stable a
Dexia Crédit Local S.A. BBB/Stable BBB/Stable bb

La Banque Postale

A/Stable A/Stable bbb+

Oney Bank

BBB/Positive BBB/Stable bb

Opel Bank S.A. Niederlassung Deutschland

BBB+/Stable BBB+/Stable bbb-

PSA Banque France

BBB+/Negative BBB+/Stable bbb-

RCI Banque

BBB/Negative BBB-/Stable bbb-

Societe Generale§†

A/Negative A/Stable bbb+

Socram Banque

BBB/Negative BBB/Negative bbb-

Commerzbank AG

BBB+/Negative BBB+/Negative bbb
Cooperative Banking Sector Germany† AA-/Negative A+/Stable aa- a+
Deutsche Apotheker- und Aerztebank eG AA-/Negative A+/Stable bbb+ bbb
DZ HYP AG AA-/Negative A+/Stable bbb-

DekaBank Deutsche Girozentrale

A+/Negative A/Stable bbb

Deutsche Pfandbriefbank AG

A-/Negative BBB+/Negative bbb bbb-

Hamburg Commercial Bank AG

BBB/Negative BBB/Developing bbb-

UniCredit Bank AG

BBB+/Negative BBB+/Negative bbb+

Santander Consumer Bank AG

A-/Negative A-/Stable bbb+ bbb
S-Finanzgruppe Hessen-Thueringen / Landesbank Hessen-Thueringen Girozentrale A/Negative A-/Stable a a-
Volkswagen Bank AG A-/Negative BBB+/Stable a- bbb+

Wuestenrot Bausparkasse AG

A-/Stable A-/Stable bbb+ bbb


BBB-/Negative BBB-/Negative bbb

Allied Irish Banks PLC

BBB+/Negative BBB+/Positive

Bank of Ireland Group PLC

BBB-/Negative BBB-/Negative bbb

Bank of Ireland

A-/Negative A-/Negative

Permanent TSB Group Holdings PLC

BB-/Negative BB-/Negative bb+

Permanent TSB PLC

BBB-/Negative BBB-/Negative

Unicredit SpA

BBB/Negative BBB/Stable bbb

Cooperatieve Rabobank UA

A+/Negative A+/Stable a

De Volksbank NV†

A-/Stable A-/Stable bbb+

ING Groep NV

A-/Negative A-/Stable a

ING Bank NV†

A+/Stable A+/Stable


BBB+/Negative BBB+/Stable bbb

Van Lanschot Kempen Wealth Management NV

BBB+/Negative BBB+/Stable bbb+

Alior Bank S.A.

BB/Negative BB/Stable bb-

Bank Polska Kasa Opieki S.A.

BBB+/Stable BBB+/Stable bbb+

mBank S.A.

BBB/Negative BBB/Negative bbb

Banco Bilbao Vizcaya Argentaria, S.A.

A-/Negative A-/Stable a-

Banco de Sabadell S.A.

BBB/Negative BBB-/Stable bbb bbb-

Banco Santander S.A.

A/Negative A/Stable a

Santander Consumer Finance S.A.

A-/Negative A-/Stable bbb

Bankinter S.A.

BBB+/Negative BBB+/Stable bbb+

Ibercaja Banco, S.A.

BB+/Negative BB+/Stable bb+

Kutxabank S.A.

BBB/Stable BBB/Stable bbb

Barclays PLC

BBB/Stable BBB/Positive bbb+

Barclays Bank PLC

A/Stable A/Positive

Lloyds Banking Group PLC

BBB+/Negative BBB+/Stable a-

Lloyds Bank PLC

A+/Negative A+/Stable

Nationwide Building Society

A/Stable A/Positive a-

NatWest Group plc

BBB/Negative BBB/Stable bbb+

National Westminster Bank Plc

A/Negative A/Stable

Santander UK Group Holdings PLC‡

BBB/Negative BBB/Stable bbb+

Santander UK PLC

A/Negative A/Stable

Virgin Money UK PLC

BBB-/Negative BBB-/Stable bbb

Clydesdale Bank PLC

A-/Negative A-/Stable
Changes are marked in bold. *Lead operating company and, where relevant holding company. Ratings on other group entities may also be affected. §Where revised. A downward revision of a bank's stand-alone credit profile (SACP) will also have led to a downgrade of its senior subordindated and other hybrid instruments. †Includes the group's core entities including DZ Bank AG and DVB Bank SE. ‡We also raised our issue credit ratings on the bank's additional tier 1 instruments.

Additional Research Contributor: Claudio Hantzsche

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Giles Edwards, London + 44 20 7176 7014;
Secondary Contacts:Regina Argenio, Milan + 39 0272111208;
Richard Barnes, London + 44 20 7176 7227;
Nigel J Greenwood, London + 442071761066;
Benjamin Heinrich, CFA, FRM, Frankfurt + 49 693 399 9167;
Elena Iparraguirre, Madrid + 34 91 389 6963;
Anna Lozmann, Frankfurt + 49 693 399 9166;
Nicolas Malaterre, Paris + 33 14 420 7324;
Mirko Sanna, Milan + 390272111275;
Michal Selbka, Frankfurt + 49 693 399 9300;
Anastasia Turdyeva, Dublin + (353)1 568 0622;

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