Large European entities such as Barclays and BNP Paribas may have to focus on their capital buffers
Investors in European banks entered the year 2022 with the expectation of a new era of great profits. Their hopes may be dashed as the war in Ukraine has increased the chances of a recession. Big players like Barclays and BNP Paribas may have to focus on rebuilding buffers against loan defaults, which are lower than before the pandemic, especially as governments have less room to support the economy.
It is true that there are positive points. Money market prices imply that the European Central Bank will raise interest rates above zero this year, while the Bank of England has already raised them three times. This boosts the income of the banks. The average net interest margin of the 10 largest banks in the UK and the euro zone will increase to 1.56% this year and 1.62% next, compared to 1.52% in 2021, according to analyst estimates collected by Refinitiv.
Meanwhile, the combined effects of the restrictions of the payout from the time of the pandemic and the rapid economic recovery have left banks with plenty of capital to spare. They have promised to return much of it to shareholders. Analysts at Bank of America estimated in February that European entities would deliver nearly €90 billion to investors through dividends and share buybacks this year and another €70 billion in 2023, up from roughly €60 billion before the pandemic.
This may now be an exaggeration. Rising energy prices and ongoing supply chain bottlenecks are holding back growth: The International Monetary Fund cut its 2022 GDP growth forecast for the euro zone to 2.8% on Tuesday, from 3 ,January 9th. Rising energy bills and interest rates make it harder for households and small businesses to service their debt. And a recession is likely if Russian gas stops flowing into the region.
Banks have relatively little bad debt reserves to protect themselves from this situation. The 10 largest European and UK banks by assets collectively had €115bn of loan loss provisions at the end of 2021, equal to 1.7% of their combined loans. Compare with 2% in 2020 and 1.8% in 2019. Banks may have to increase those buffers if the economy tanks, cutting into their profits. Especially since governments and central banks have less room to intervene with fiscal stimulus or rate cuts, respectively. Public debt has skyrocketed in the past two years and inflation is at its highest point in decades in many major developed economies.
There is no doubt that banks are in a better position now than they were in early 2020. But hopes of a dividend bonanza are increasingly difficult to square with a deteriorating economy.
