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15. Nov 2016 Scope research

Financial Institutions Outlook 2017: Europe’s banks bolster balance sheets, but profitability lags

Scope Ratings’ 2017 outlook for European banks, published today, highlights the various challenges still facing the sector, from structurally low profitability to political risk and competition from fintechs.

In its annual outlook report for the European banking industry, Scope says that it expects its bank ratings to be relatively stable in 2017, with some strengthening of bank balance sheets potentially offset by continued challenges to earnings.

Unlike other market observers, however, Scope points out that the current regulatory architecture – including proactive supervision – continues to make the sector safer for credit investors.

According to the rating agency, proactive supervision means potential problems at the banks should be tackled early on, hence reducing the likelihood of losses hurting bank-credit investors. Scope believes that the sector is nearing the end of the years-long build-up of capital, which has been driven by tougher regulatory and market demands. Most of the regulatory architecture is now firmly in place, and most banks already comply with their CRD IV fully phased requirements.

Looking at balance sheet trends, the rating agency expects some further improvement in asset quality, as the stock of legacy non-performing loans benefits from the better macro environment, especially in the euro area periphery. Such improvements may not suffice, however, to boost return-on-equity ratios, which may remain unsatisfactory for many banks for the foreseeable future.

“Many banks have built what less than 10 years ago was only an aspiration even for the strongest of them – a very conservatively shaped balance sheet, with a large equity base and limited volatile market funding,” says Marco Troiano, who authored the report. “Earnings have not kept pace with the growth in capital though, and currently remain challenged,” he adds.

The report highlights that low profitability stems from a number of structural, rather than cyclical, factors, including (i) persisting softness in credit demand – largely due to slow growth and the excess debt overhang in the European economy; (ii) a flat yield curve and ultra-low, or even negative, interest rates; (iii) excess capacity; and (iv) the non-bank supply of financial services, including from fintechs.

Against this mixed outlook, Scope expects banks to continuously review strategies and adjust business models – for most of the 26 rated large banks, and other large banks as well. Scope’s analysts expect cost-cutting to remain a key profit lever for 2017. More generally, the rating agency sees consolidation as necessary to remove excess capacity from the market and restore sector profitability.

Scope’s report also highlights that political risk is an increasingly important factor potentially affecting, through second-round effects, bank fundamentals. With next year’s elections in Germany and France, on the back of Brexit in the UK and the recent US elections, headline political risk is increasing.

Download the full report: 'European Banking Outlook for 2017 and Beyond: Balance Sheet Safety vs Profitability Challenges'.

Analyst Conference Call

Scope Ratings discusses its European banking outlook in a telephone and web conference call on Wednesday, 23 November 2016, 3:00 pm UK time.

Following a brief presentation, our analysts will be available to take questions.

When: Wednesday, 23 November 2016 at 3:00 pm UK time
How: Conference call and web presentation
Analysts: Bank ratings team

Please register here.

Contact

Scope Ratings AG    Phone: +49 30 27891-0
Marco Troiano    m.troiano@scoperatings.com
Samuel Theodore    s.theodore@scoperatings.com
Oliver Müller    press@scopegroup.com