Europe’s banks have 3 main challenges ahead as coronavirus crisis drags

Europe’s banks have 3 main challenges ahead as coronavirus crisis drags

People wearing face masks walk in front of a big Euro sign in Frankfurt am Main, western Germany, as the European Central Bank (ECB) headquarters can be seen in the background on April, 24, 2020.

Yann Schreiber | Getty Images

Question marks still linger for the top European banks as they enter the second half of a year blighted by the coronavirus pandemic.

On the whole, these lenders have ended the latest earnings season largely beating expectations for the quarter. Profits were supported by lower costs, but also by higher trading volumes in equities and an overall rebound in global markets.

But, they face some tough challenges going forward.

“The outlook still looks relatively challenging,” Hugh Gimber, a global market strategist at JPMorgan Asset Management, told CNBC Friday. “The earnings were better than expected,” he said, “but still they have been pretty weak.”

Investors are questioning the level of provisions against loan losses; if they can stand up to competition from Wall Street; and how long this crisis will actually last.

If I put everything together, I do expect the second half of the year maybe not to be as benign as the first half, but still quite robust.

“Provisions remain the largest source of uncertainty,” Francesco Castelli, head of fixed income at Banor Capital, told CNBC this week, pointing to an inconsistency among European banks.

“We saw this ratio (of loan loss provisions) increasing up to five times at some banks while other institutions remained much less conservative,” he added.

These provisions, effectively cash set aside for potential coronavirus-related loan losses, have been a feature of the last two quarters. BNP Paribas added 329 million euros ($389 million) in the second quarter. Deutsche Bank had allocated 761 million euros by the end of June. Meanwhile, UniCredit in Italy registered 937 million euros during the same period.

The second-quarter figures also revealed, as it is often the case, a stronger performance by the big U.S. lenders in comparison with their European peers.

“U.S. franchises have done much better in investment banking and trading, clearly outperforming their smaller European competitors and further cementing their leadership position,” Castelli told CNBC, suggesting this “overperformance” will add further pressure on European lenders, “where more restructuring is to be expected.”

 The Dow Jones U.S. banks index is about 2% higher over the last month. In comparison, the Europe Stoxx 600 banks index has nudged lower over the same period.

Finally, it is difficult to predict for how long the health crisis and subsequent economic shock will last. Though banks managed to surprise in the second quarter, they might be on track for more acute pain.

“The outlook is very much tied to the (health) crisis,” Gimber from JPMorgan Asset Management said.

This was raised previously by the chair of the European Central Bank’s supervisory board, Andrea Enria, who told CNBC in an exclusive interview that European lenders could soon face difficulties if the current crisis deepens and erodes their capital positions.

The supervisory body stress tested 86 banks in the euro area and concluded that they can cope with the current crisis, but if it persists, there could be a “material” loss in capital.

Nonetheless, some investors are confident that the increased capital on the balance sheets will help them weather the storm.

“While losses will sure be considerable, European banks start with a very strong capital position,” Castelli said, adding that the average common equity tier 1 ratio — a metric of capital strength — is more than twice the level seen in 2007 before the global financial crisis.

This, coupled with a European-wide plan for massive fiscal stimulus, should support lenders in the medium term, Castelli also said.

“If I put everything together, I do expect the second half of the year maybe not to be as benign as the first half, but still quite robust,” Sergio Ermotti, the outgoing CEO of UBS, told CNBC last month.

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