Higher interest rates won’t pay European banks right away

Rising interest rates are not the mere boon to long-suffering European banks that they might first appear. Patience will be required.

European bank stocks have outperformed strongly this year, rising around 6% even as the broader market fell. These are economic indicators, so signs of recovery have supported them, alongside other cyclical stocks, since the Covid-19 vaccines proved their worth at the end of 2020. Now there is also enthusiastic talk of interest rates from higher benchmarks, although with a lag in the euro area compared to Great Britain and the United States

The status quo for banks is to make money on the money they lend, so if the interest rate they can charge goes up, so should their income. Unfortunately, it’s not that simple anymore. The extraordinary financial support measures introduced in response to the pandemic must be lifted before the banking system returns to normal.

European bank stocks have outperformed strongly this year.


Photo:

Constantin Zinn/Shutterstock

As the pandemic shut down economies in 2020, governments have relaxed policies where possible. Central banks slashed lending rates and restarted quantitative easing, government furlough programs paid wages, and borrowers got government-backed payment holidays or emergency loans. European banking regulators have changed the deep rules of financial plumbing to ensure that banks continue to lend to support the economy while maintaining healthy capital cushions. Officials adjusted interbank lending rules and rates, reduced capital requirements and banned dividends and bonuses.

All help worked. Banks built up massive loan loss provisions to prepare for the worst, but in the end they weren’t really tested.

Now that things are looking up, it’s time to take the supports off, slowly. One of the first things to come was the ban on shareholder returns, which should trigger a windfall of buyouts and dividends this year. The unwinding of many other policies will take longer, and the way they are interconnected makes it difficult to predict how the process will affect bank profits, even if higher interest rates are still in the headlines.

A good example of this is the European Central Bank’s latest Targeted Longer-Term Refinancing Operations, quickly known as TLTROs, which will take place in the second half of 2022. risk-free income base: for example borrowed at -1% and returned at -0.5%.

The TLTRO has given European banks about €8 billion in additional revenue, according to Bank of America’s Alastair Ryan.

However, the program also had the ripple effect of compressing interest rate spreads, which Mr Ryan said could have cut banks’ profits by €68 billion. So reversing one could affect the other and these are just two of the many moving parts of this almighty tangle.

Great normalization will take time. European banking investors should find that interest rate increases ultimately mean higher profits. In the short term, however, they may have to console themselves with a generous flow of buybacks and dividends.

Write to Rochelle Toplensky at [email protected]

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