Negative rates: European banks must reinvent themselves in search of profit


To achieve long-term profitability, European banks must break free from their dependence on net interest income because several years of low and negative interest rates have threatened the viability of traditional business models, according to market watchers.

As lenders prepare for at least a few more years at sub-zero rates, in part thanks to pressures from the COVID-19 pandemic, they will be forced to rethink their main source of income and consider a shift. to others, more lucrative. , cash flow. Otherwise, the continued pressure on net interest income will limit income growth, hurt banks’ bottom lines and limit their ability to invest, making them less competitive and prone to take more risk.

Despite efforts to diversify, net interest income still represents 58.9% of the total income of European banks at the end of 2020, show data from the European Banking Authority. The EBA has warned that bank profitability is likely to remain very low amid net interest income and pressure on margins, posing a risk to the long-term viability of many institutions.

According to Elizabeth Rudman, Head of the European Financial Institutions team, strong and diversified commission income from areas such as capital markets, payments, insurance products, wealth management and trade finance , are one of the most effective tools to offset the net pressure on interest income. at DBRS Morningstar. Shifting the balance to commission income won’t be easy, but some banks should be able to manage it within the next three to five years, she said.

Under pressure

Europe’s biggest banks have struggled to increase their net interest income since the European Central Bank introduced negative rates in June 2014, according to data from S&P Global Market Intelligence.

Net interest margins – which measure the net interest income generated by loans against the interest banks pay to savings accounts and deposit holders – are declining, with notable declines in 2019 and 2020.

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While banks may have eased the pressure on net interest income somewhat thanks to the growth in pre-COVID-19 lending, this trend has subsided in the wake of the pandemic as a drop in consumer spending amid the blockages resulted in increased deposits. In 2020, euro area banks paid the ECB € 8.5 billion in negative interest charges, the highest amount on record, according to data from German fintech company Deposit Solutions.

Learn more about the impact of negative rates here: Pressure on margins could prompt banks to take more risk

Zero or negative interest rates can have “a devastating impact” on long-term banks’ loan portfolios, as new, low-rate loans replace the best maturing loans, McKinsey said in its annual Global Banking Review 2020. Current banking business models mean that the nthe negative effects can easily spread to all components of the balance sheet, he added.

Retail banking and corporate banking remain by far the largest contributors to banking income, but these activities are sensitive to a zero interest rate environment. On the flip side, paid businesses are a much smaller share of the bank’s revenue pool, but have made the banks that have them more resilient in the midst of the pandemic, McKinsey said.

Swiss groups UBS Group AG and Credit Suisse AG were among the best performing European banks last year thanks to their wealth management and investment banking units. Indeed, investment banking has been the key to the growth of many European groups in 2020, including Deutsche Bank AG, which posted its first annual profit in six years despite the pandemic and ongoing restructuring.

The aggregate net income from fees and commissions represented less than half of the total amount of net interest income of Europe’s largest banks over the past five years, according to Market Intelligence data.

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Mitigation can only go so far

So far, in order to offset the pressure on net interest income, banks have mainly used the targeted longer-term refinancing operations programs, or TLTROs, and applied a negative rate on deposits from businesses and, more recently, individuals. These measures are not a panacea to the problem, however, and have only reduced, but not remedied, the impact, analysts said.

Total bank borrowings in the latest TLTRO III program reached 2.19 billion euros in June, while excess bank liquidity since the start of COVID-19 has increased by around 2.4 billion euros. euros, says ABN Amro. “Basically the amount that was borrowed through TLTRO is less than that parked at the ECB, so the banks are losing money,” Tom Kinmonth, fixed income strategist at ABN Amro, said in an interview.

Although many banks have started to charge negative rates on retail deposits, the financial benefit remains limited for now and lowering deposit thresholds for negative charges cannot last forever, as banks must preserve their market share.

“There are limits to the negative way you can go [as] people would have finally take their cash “Scope Ratings analyst Marco Troiano said in an interview. In Denmark and Germany, the deposit thresholds for negative rates have already been lowered to € 10,000 in some cases.

According to Scope, negative rate charges on retail deposits pose business, legal and reputational risks for banks. By avoiding interest charges now, they risk losing cash-rich clients for the future. “While this may not appear to be a huge immediate loss, it would deprive the bank of income potential as well as a future funding option,” the rating agency said in a recent report.

Need for change

Retail banking is changing as COVID-19 has accelerated existing long-term trends, including the demise of branches and the shift to large-scale digital offerings, said Strategy &, a unit of consulting firm PwC, in its last sectoral report.

“Retail banking is under a lot of pressure. People don’t want to do current accounts, banks cannot easily charge negative rates to customers, so banks are leaving retail,” Kinmonth said, stressing the recent sale of HSBC Holdings PLC in France; and ING Groep NV’s plan to leave Czech retail banking and review its operations in France.

Banks should focus on optimizing product offerings and prices, as well as finding additional revenue from fees and commissions by redeploying deposits, said Andreas Pratz, partner at Strategy &. Streamlining of branches to reduce costs, as well as increasing pressure for pan-European consolidation among retail banks are expected over the next few years, he said.

the longer term viability traditional business models focused mainly on retail and commercial banking is at risk, especially when it comes to small regional banks, according to Troiano. Cost reductions, repricing and redeployment of assets are effective measures, “but the reality is this the are too much a lot banks and do not sufficient request for everyone at to be profitable “, and therefore the sector is bound to contract more than the way at in the long run, he says.


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