Central bankers are meant to slow economies down by quietly removing the party punch bowl, not by pouring its contents over investors’ heads. A spate of US bank failures and the shotgun marriage of UBS and Credit Suisse point to just such a drenching. The MSCI European banks index fell nearly 13 per cent last month while the broader market managed a tiny gain.
Should central banks relent in their quest to quell inflationary pressures, just in case other banks collapse? A furious debate is raging on that point. In March, the US Federal Reserve and the Bank of England raised rates by a quarter point rather than half a point. The slow-moving European Central Bank went larger, then sounded a note of caution
What is the outlook for European banks in this treacherous environment? Interest rate policy is crucial to performance via its impact on net interest incomes. These are boosted by higher rates in general – and by wider spreads between long- and short-term interest rates in particular. Another factor is the pace of credit growth.
For retail-focused banks such as Lloyds in the UK or Spain’s Sabadell, net interest income makes up 80 to 90 per cent of total revenues. The shares of both have done well since September. Barclays has an NII of 60 per cent of revenues. Its stock has gone nowhere.
If inflation in the UK and Europe slows later this year, as Saltmarsh Economics forecasts, investors will expect NII improvements to do the same. February declines in inflation in Spain and France already hint at this.
Loan repricing began late last year and should continue into 2024. European net interest margins should climb to 1.82 per cent in 2023 and go slightly higher in 2024, think analysts at Citi.
The next question is what happens to credit volumes. The ECB says that during the last quarter of 2022 the “net tightening in credit standards was the largest reported since the euro area sovereign debt crisis in 2011”. Lending to non-financial groups in the euro area is decelerating. The UK series was barely positive in February.
There is a big risk European NIIs will undershoot the market’s expectations. The balance of opinion has an inertia all its own, which has yet to internalise recent left-field financial shocks fully. On that basis, European bank stocks look like a poor investment.
The Lex team is interested in hearing more from readers. Please tell us what you think of European banks in the comments section below.