European banks have shown strength during Covid-19

It could have been another 2008 banking crisis, but as it turns out, European banks have weathered the challenges of Covid-19 with great resilience. Despite this, they still face other challenges that could upset their future outlook, especially consumer debt and interest rates.

This time around, banks have ended up in a much stronger capital position than back in 2008, due to the regulations introduced in the wake of the financial crisis. Some are in such a buoyant position that they are ready to resume dividend payouts this year, Silvia Amaro writes at CNBC. 

Arnaud Journois, vice president at DBRS Morningstar told Amaro, “The most important takeaway is that we have not seen a deterioration in asset quality yet since the onset of the crisis.” This view of ‘strength’ is backed up by Fahed Kunwar, head of European banks equity research at Redburn, who said its latest quarterly results have been ‘Strong”.

The big lenders have benefited from government stimulus measures introduced across EU countries, and business failures have been contained due to steps taken by the European Central Bank and the Bank of England. However, there are fears that this situation may not continue into 2022 as “fiscal and monetary interventions are potentially scaled back.”

Nick Andrews, Europe analyst at investment research firm Gavekal told CNBC, “Bad loans will start to appear over the next year or so. That’s when we will get a clearer picture of how bad the situation is in the corporate sector.” A view that is echoed by Elisabeth Rudman, head of European financial institutions at DBRS Morningstar, who also said, “the full level of non-performing loans is still to materialize.”

While governments haven’t made concrete announcements about their withdrawal of financial support, this is bound to happen as the health crisis slows down and economies reopen. When it happens, some businesses will be too stretched to meet their loan repayments and may have to file for insolvency.

The interest rate challenge

Jes Staley, CEO of Barclays, commented on interest rates, saying, “One risk given the level of government spending is if interest rates do start to move up markedly, that will increase the cost of trying to respond to the pandemic.”

As we know, interest rates are at a record low level after being cut as part of the economists’ response to the pandemic. However, central banks could raise the rates if prices rise significantly. There may be less risk attached to this in the Eurozone, where recent increases in inflation were associated with one-off events, such as Germany’s new consumer tax rules.

But in the UK, economists are predicting that prices “could overshoot the Bank of England’s inflation target later this year,” and that would likely result in an interest rate rise. If this happens, it will be bad news for the UK economy in general.

The big hope for the banks is consumer spending once restrictions are eased and restaurants and shops re-open. Andrews from Gavekal said, “We could see a stronger rebound on the back of pent-up demand,” which would ultimately support the banks’ balance sheets and draw in more business investment.

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