Europe’s leading banks, including Deutsche Bank and Lloyds Banking Group, have raised concerns over the escalating threat of bad loans amidst the current global economic challenges marked by sluggish growth and surging inflation.
As financial regulators and investors closely monitor the banking sector’s performance during this uncertain economic climate, the focus has shifted to how banks in Europe manage their loan books and identify signs of potential stress.
In the recent flurry of bank earnings reports in Europe, a few key trends emerged in the global banking landscape. Investment banks are experiencing pressure due to a deal drought, while retail banking profitability is benefiting from higher interest rates.
Lloyds Banking Group reported taking a higher charge for troubled loans, resulting in first-half profit falling short of expectations. The economic slowdown in Britain weighed heavily on the bank’s finances, prompting calls for further actions from management to assist savers. The unexpected surge in potentially soured loans, amounting to $855 million, and declining loan volumes led analysts at JPMorgan to predict downgrades in Lloyds’ performance for the year. As a consequence, Lloyds’ shares were down three per cent early on Wednesday.
In contrast, higher interest rates have been a boon for UniCredit, allowing the bank to significantly exceed earnings expectations in the second quarter. Although UniCredit foresees an increase in its cost of risk, CEO Andrea Orcel asserted that it would be less severe than initially anticipated. Orcel expressed cautious optimism. “We don’t expect an Armageddon increase in the cost of risk,” he said, adding that expected shocks would be pushed further into the future.
While the International Monetary Fund (IMF) marginally revised its 2023 global growth estimates upward, it cautioned that persistent challenges continue to dampen the medium-term economic outlook. Inflation has moderated, and acute stress in the banking sector has subsided; however, the IMF emphasized that risks to the global economy remain tilted toward the downside, and credit remains tight.
The European Central Bank (ECB) reported a significant drop in euro zone companies’ demand for loans during the last quarter, reaching the lowest level on record. The trend is expected to continue throughout the summer as banks tighten access to credit. In response to the growing concern about bad loans, Germany’s financial regulator, BaFin, has urged banks to increase the provisions for such risks.
Deutsche Bank revealed that provisions for bad loans nearly doubled in the second quarter compared to the previous year, amounting to $455 million. James von Moltke, the bank’s Chief Financial Officer, highlighted a “softening in some sectors,” signaling potential trouble areas. The bank adjusted its guidance, expecting provisions for souring loans to be at the higher end.
Meanwhile, Santander, a major Spanish bank, reported weakness in its key market, Brazil, with net profit plunging 52 per cent year-on-year in the quarter. Rising costs attributed to inflation, negative tax impacts, and a decline in net interest income have contributed to the challenges in the Brazilian market. However, Santander’s financial chief expressed optimism, suggesting that bad loans in Brazil may have already peaked.
European Union banking regulators are preparing to release stress test results later this week, evaluating banks’ resilience during an extended period of high inflation and interest rates. The ECB’s decision to raise euro zone borrowing costs to the highest level in 22 years has positively impacted some banks’ performance. UniCredit, for instance, raised its net profit and shareholder reward targets for the year after experiencing a 25 per cent year-on-year surge in revenues. As a result, the bank’s shares rose around 2 per cent on Wednesday, with Jefferies forecasting further upside potential to net interest income.
(With Inputs from Reuters)
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