European banks benefit from rising interest rates – but the risks are great

Frankfurt After the balance sheet figures of the US banks, investors are looking forward to Europe in the coming days. One topic in particular should then be in focus again: the turnaround in interest rates.

Since last summer, the European Central Bank (ECB) has raised interest rates in the euro area four times in a row, most recently to 2.5 percent in December. The currently even more important deposit rate, which banks receive for their deposits at the ECB, rose from 1.5 to 2.0 percent. The euro currency guardians want to fight the still high inflation with the interest rate hikes.

The Bank of England (BoE) also recently raised interest rates in the UK by 50 basis points to 3.5 percent. The highest level in 14 years and at the same time the ninth interest rate hike in a row.

The banks benefit from this. “We expect positive results from European banks due to rising interest income,” said DRBS Morningstar analyst Sonja Förster. In addition to the rise in interest rates, the trigger is also inflation, which triggers an increasing demand for credit from financial institutions.

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This has already been shown by the US banks, which have also benefited from the US Federal Reserve’s rising interest rates. At JP Morgan Chase, net interest income rose to just over $20 billion in the fourth quarter – a new record and up 49 percent year-on-year. Interest income also increased significantly at the end of last year at Bank of America, Citigroup and Wells Fargo.

>> Read here: Scalable Capital offers 2.3 percent interest on call money

In Europe, Commerzbank is one of the biggest beneficiaries of the turnaround in interest rates thanks to its large deposit and lending business. On average, analysts assume that net interest income at Germany’s second-largest private bank rose by around a quarter last year. The bottom line is that the institute is estimated to have made a profit of 1.3 billion euros – after 430 million euros in 2021.

Analysts are also expecting profits to rise at Spain’s Santander Bank and France’s BNP Paribas. At BNP they expect an increase of around eight percent to 10.3 billion euros, at Santander by almost 15 percent to 9.3 billion.

Competition for savings is getting tougher

The rate hike should have an even greater impact on British financial institutions. “The British central bank has raised the key interest rate faster and more strongly,” emphasizes analyst Förster. In addition, there is a high proportion of fixed-interest loans in Germany and France, for example. In the UK, on ​​the other hand, many loans have variable interest rates. The repricing of the loan book is reflected more quickly in interest income in Great Britain, explains Förster.

Analysts at the British HSBC assume on average that the bank was able to increase its earnings in the fourth quarter by almost 20 percent to a good 14 billion dollars. According to estimates, consolidated net income almost doubled to $3.7 billion in the last quarter of last year.

However, it remains questionable whether this trend will continue in the current year. JP Morgan dampened expectations of a further rise in net interest income. As a new goal for 2023, the bank named $ 74 billion in interest income. This is below the forecasts of many analysts.

Analyst Förster is not surprised: “Competition between banks for customer deposits is likely to increase further in 2023. However, this will have a negative impact on the future interest income of the institutes, because they have to offer their customers more attractive conditions”.

If banks don’t do this, customers can switch their funds to other products – or switch to the competition altogether. In Germany, neo-brokers such as Trade Republic and Scalable Capital already offer two and 2.3 percent interest on call money respectively.

>> Read here: That’s behind Trade Republic’s interest rate offensive.

If the central banks continue to raise interest rates, concerns about a recession are likely to grow. Added to this are the war in Ukraine, high energy prices and disrupted supply chains. That should lead to more company bankruptcies – and also hit the financial institutions.

Experts assume that loan loss provisions at many banks, such as the Italian Unicredit and the Dutch ING, increased in the fourth quarter. From analyst Förster’s point of view, however, the situation is not dramatic, she speaks of a “normal level” of risk provisioning. “Demand is currently limited because many reserves were built up during the Corona period,” she said. The banks are still living on it.

In addition, although there is a risk of a recession, there are currently signs that the recession is likely to be mild, says Förster. According to the latest data, Unicredit boss Andrea Orcel is even optimistic that the euro zone could avoid a recession altogether.

Investment banking slump

In addition to increasing risk provisioning, the weakening investment banking is also affecting some banks. With the start of the Ukraine war and rising interest rates, business with IPOs and mergers and acquisitions collapsed.

In the USA, several large banks have recently felt the effects. Investment banking revenues at Goldman Sachs fell 48 percent in the fourth quarter compared to the year-ago quarter and at Morgan Stanley they fell 49 percent.

In Europe, the slump impacted Deutsche Bank, among others. It is estimated that the bank earned significantly less in investment banking in the fourth quarter of 2022 than the average for the first three quarters. This is also indicated by the institute’s planned bonus payments, which should be around ten percent lower in the investment bank.

>> Read here: Banks in the EU are paying more and more salaries in the millions

According to estimates, the more stable business areas such as private and corporate customer business are unlikely to have compensated for this dip, although both areas have benefited from both the rise in interest rates and good new lending business.

Overall, Germany’s largest financial institution is likely to have earned more in the traditionally difficult fourth quarter of 2022 than a year ago. However, it was probably not able to build on the profitability in the first three quarters of 2022.

For the year, analysts assume that Deutsche Bank has made a profit of more than four billion euros. That would be the best result in more than ten years. According to analyst estimates, CEO Christian Sewing could have just missed the target of a return of eight percent on tangible equity that was set years ago at 7.8 percent.

However, positive signals can be expected from the bank’s trading departments. These should benefit from the volatile stock market environment and from the fact that many investors are restructuring their portfolios due to fears of inflation and recession. This was already shown by the figures from the US banks.

From the point of view of DRBS-Morningstar, given the economic situation in 2023, European banks face a difficult task. Still, balance sheets should continue to benefit from interest rate hikes, and “remain strong thanks to generally sound capitalization and ample liquidity.”

In the coming week, Unicredit, UBS, Santander and Deutsche Bank will first present their figures. A week later, the major French banks, among others, also reported. Commerzbank and the British financial institutions form the conclusion.

more on the subject: JP Morgan profits from interest, Goldman Sachs burns billions

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