With the eurozone economy slowing sharply, banks are likely to begin to see a rapid reduction in loan volume growth and overall economic activity this winter, warned S&P Global Rating analyst Nicolas Charnay. However, thanks to a good start to 2022 and rising interest rates, “we expect euro area banks to perform very well this year and, in our baseline scenario, also into 2023”.
Indeed, economists at S&P Global Ratings believe that a sharp slowdown in the eurozone economy is imminent. A slowdown that would be mainly driven by a contraction in consumption, which could be quite significant in the last quarter of 2022 and in the first quarter of 2023. Investments should also suffer from the lack of visibility on the evolution of the war between Russia and Ukraine and the businesses will see a slowdown in consumer spending. For euro area banks, this will undoubtedly lead to a reduction in commercial activity and lending volumes.
S&P simulates the potential impact of two macroeconomic scenarios on eurozone banks’ earnings.
For the next year, the S&P Global Rating expert simulated the potential impact of two macroeconomic scenarios on euro area banks’ earnings: stagnation (baseline scenario) and full economic recession, albeit potentially in the short term (negative scenario ). In both scenarios, “we believe that the euro area banking system will remain profitable, albeit to a lesser extent in the negative scenario”.
In particular, the results for the full year 2022 should remain substantially positive thanks to the strength of the first half. “We estimate that systemic banks in the euro area, or the 110 largest banking groups under the supervision of the ECB, will show an average return on equity of between 6.1% and 7% in 2022, broadly stable compared to the previous year. 6.7% last year. For 2023, performance will ultimately depend on the possibility of a recession in the eurozone. Our economists now estimate a 47% chance that will happen, even though their baseline scenario is relatively smaller. conducive to stagnation “, underlined the S&P expert.
In the negative scenario, the new provisions should reach up to 100 billion in 2023.
A scenario that would see a slight increase in profits for Eurozone banks, with gradual increases in interest rates that more than offset the increase in costs. “In our negative scenario – a full but short-lived recession – the increase in the interest margin would be more contained, while the cost of credit could jump to the levels seen at the beginning of the pandemic. In this case, the banks in the euro area would experience depressed profitability, well below their cost of capital, with an average ROE (return on capital, ed) estimated at 2.4% -4.6% against 5, 5% -7.2% of the baseline scenario, Mr. Charnay estimated.
The expert also predicts that provisions will increase to a level similar to that seen at the height of the pandemic, which is between 80 and 100 basis points of total customer loans: “In this scenario, we estimate that provisions could increase to 110 billion. euro in 2023 compared to the 64-66 billion euro estimated this year still in the negative scenario (55 billion euro in 2021, 58-62 billion euro those estimated in the base scenario in 2022 and 71-82 euro in 2023, note) , close to the levels observed in 2020 at the beginning of the pandemic (118 billion euros for all major systemic banks in the euro area, or 1.1% of total loans to customers) “. However, even in this scenario , eurozone banks would continue to post pre-tax earnings in 2023 as a whole. That said, “we do not rule out that some eurozone banks may be at a loss in this scenario, given their different models. and the composition of their loan portfolio “, further indicated the analyst of S&P.
A recession could also erode capital ratios
For most eurozone banks, a recession could also erode regulatory capital ratios, as higher risks inflate risk-weighted assets (RWAs). However, “these factors are unlikely to pose a serious threat to banks’ overall financial strength and resilience given the rising rate environment. Furthermore, euro area banks entered the crisis with high capital and liquidity buffers, which should help them overcome these risks. Asset quality will be critical and the ultimate impact of a recession on banks’ provisioning will largely depend on each bank’s relative exposure to riskier sectors, ”he stressed.
S&P assures: no action on ratings if the downside scenario materializes
Of course, the impact of the adverse scenario depends on each bank’s relative exposure to riskier sectors. It also depends on the banks’ ability to manage and absorb growing credit risks and the pace and strength of the subsequent recovery, which in turn depends on possible government intervention. “We currently do not plan to take any large-scale rating action if the bearish scenario materializes. However, we could assign a negative outlook or downgrade ratings if we start to see individual banks less resilient than our current ratings predict, “warned Nicolas Charnay. (Narrow breeding)