Virus-driven rate cuts and branch reliance set to impact European banks

Coronavirus-driven base rate cuts are expected to squeeze European banks’ net interest margins and push profit targets out of reach, while lenders with large branch networks, including those in Italy, are likely to be disproportionately affected by COVID-19, analysts say.

Central banks slashed policy rates and European stocks tumbled after the open on March 9, with the FSTE 100 index falling around 8% at 1:50 p.m. London time.

Central bank action

The US Federal Reserve cut its key policy rate by half a percentage point on March 3, after G7 finance ministers and central bank governors pledged to use all appropriate policy tools to deal with crisis.

The Bank of England’s monetary policy committee meets on March 26, with outgoing Governor Mark Carney saying there is the equivalent of 200 to 250 basis points of interest rate margins when new asset purchases are included, although base rates currently stand at 0.75%.

Canada lowered its key rate by 50 basis points and the ECB could follow suit at its March 12 meeting.

“Base rate cuts will put pressure on the net interest margin – lower spreads due to the lack of lower bound effects in a deposit environment and structural hedges which will ultimately result in higher low if lower base rates persist,” stockbroker Goodbody wrote in a note.

Scope Ratings said the virus is putting intense pressure on European banks, but the sector is likely to escape a full-scale crisis.

“The most immediate risk is a sharp decline in turnover revenue in areas such as wholesale and investment banking, lending and asset management – ​​potentially followed by an increase in quality issues. assets if economies deteriorate markedly,” the rating agency said in a note.

Impact on Italy

Italy has been the most affected country outside of Asia, with a total number of confirmed cases of 7,375 so far, according to a March 8 statement from Italy’s civil protection department. Some 16 million people are said to be confined to the north of the country by order of the government.

“We expect the Italian banking sector to be negatively affected by the significant slowdown in the Italian economy, especially in the northern part of the country, which has the richest and most productive regions,” said Nicola de Caro, senior vice president and principal Italian banking analyst at DBRS Morningstar, said in an email.

“For the banking sector, the current slowdown and uncertainty will weigh on revenues, due to the combination of lower net interest income due to lower rates and lower lending volumes, as well as from falling fees and financial income amid sharply falling market valuations,” he said. He added that asset quality will also be affected, with non-performing loans and provisions likely to increase.

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Banco BPM SpA has seen the biggest drop in share prices among major European banks following the outbreak, with shares down 32.04% between February 24 and March 6. Its main activities are in the Italian regions of Veneto and Lombardy, which have been at the heart of the epidemic.

Other major Italian banks have put in place measures to stop the spread of the virus and help those affected, including closing branches and suspending travel. These steps are “a positive factor in ensuring business continuity,” according to a March 6 note from DBRS Morningstar.

UniCredit SpA and Intesa Sanpaolo SpA, meanwhile, have pledged moratoria on mortgage and loan repayments for customers affected by the outbreak.

Italian banks could face a greater impact due to their reliance on branches to distribute products. Investment bank Berenberg, in a March 4 memo, said customers may be less willing to visit branches during the outbreak, potentially causing more disruption for banks with larger branch networks. important.

Spain and Italy have the highest branch densities of Western European countries, according to IMF data. Banco BPM has 1,784 branches, and UniCredit and Intesa Sanpaolo have 3,769 and 5,386 respectively, according to data from S&P Global Market Intelligence.

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Wholesale Financing

Banks are much less dependent on interbank funding than they were during the financial crisis, Goodbody noted, said there were concerns about wholesale funding costs and even suggested that lowering interest rates the Fed was partly in response to pressure from investment banks concerned about the issue. He suggested to the Bank of England the term financing mechanism, which allowed banks to borrow long-term from the central bank at rates close to base rates, could be renewed.

Investment banks are likely to be hit hard due to uncertainty delaying business activity, as well as travel restrictions slowing business in general, which Standard Chartered PLC has previously indicated. The bank has broad exposure to emerging markets and a strong presence in China and Hong Kong, and has already pushed back its profitability targets due to the effect of the virus on its markets.

Although the bank did not quantify the impact of the virus during its annual results presentation, CEO Bill Winters said its March performance would be affected.

He said trade flows and consumer sentiment were down and the propensity to invest in capital projects had been affected. But, he said, in Hong Kong more than two-thirds of StanChart branches are now open as the virus appears to have peaked.

Asia Exhibition

Standard Chartered and HSBC Holdings PLC, with their exposure to China, Hong Kong and other parts of Asia, are likely two of the banks hardest hit by the virus, according to ING.

“The spread of the virus will likely result in higher expected loan losses, lower revenues and lower volume growth. Any resulting credit rating migration is likely to increase risk-weighted assets and therefore have a negative effect on capital ratios,” he said. in an analyst note.

It considers that HSBC is better placed of the two banks to absorb the effects due to its stronger capital position and its better ability to generate capital.