Bank Profitability in Europe: Not Here to Stay

IMF Working Papers, July 9, 2024

Source details

Authors: Ruo Chen, Vincenzo Guzzo, Fazurin Jamaludin, Adil Mohommad, Ritong Qu, Yueshu Zhao
Published: July 9, 2024
Series: IMF Working Papers
DOI: https://doi.org/10.5089/9798400281204.001

Slower passthrough of policy interest rate hikes to deposit rates relative to their loan rates has led to sharply wider bank net interest margins.
Wider net interest margins, combined with resilient asset quality, supported record profits for European banks in 2023.
Drawing on historical data from the balance sheets and income statements of over 2,500 European banks, the paper shows that abnormally high profits are expected to fade soon as interest income will decline once policy rates start being lowered.
Higher impairment costs historically have weighed on profits with a lag.
A number of structural factors that have eroded the performance of European banks in the past two decades have largely remained unaddressed and will continue being a drag on profits and capital.

Dataset: balance sheets and income statements of over 2,500 European banks.
Coverage: analysis of historical patterns in interest income, impairment costs, net interest margins, asset quality, profits, and capital.
Outcome: projection that elevated profits are temporary and linked to the current interest rate cycle and delayed impairment recognition.

Interest rate passthrough:
- Deposit rates have risen more slowly than loan rates, widening net interest margins.
- Once policy rates are lowered, interest income is expected to decline, reducing net interest margins and profits.
Impairments and timing:
- Higher impairment costs have historically followed profit upswings with a lag, implying future profit pressures as impairments materialize.
Asset quality:
- Resilient asset quality supported profits in 2023 but may not persist as lagged impairments emerge.

The paper identifies multiple structural factors that have eroded European bank performance over the past two decades; these factors remain largely unaddressed and will continue to weigh on profits and capital.
Implication: even beyond cyclical pressures from interest rate normalization, structural weaknesses pose a longer-term constraint on bank profitability and capital accumulation.

Policymakers should:
- Encourage banks to preserve capital buffers.
- Encourage banks to build resilience to future shocks.
- Exercise caution when considering taxes on profits or other measures that could divert potential sources of capital from banks.