Banks around the world have been crucial throughout 2020 in stabilising their respective economies. They have ensured that liquidity continues to be transmitted to the real economy, which in turn has helped to prevent a full-blown credit crisis from emerging as happened during the 2007-09 global financial crisis. And in certain jurisdictions such as the eurozone, the United States, Japan and the United Kingdom, banks have also played a hugely important role in the effective dissemination of funds originating from their central bank’s quantitative-easing programmes.
But despite the recent positive news of COVID-19 vaccines being developed, it seems that quantifying the overall impact of the coronavirus on the eurozone will remain an impossible task for quite some time. The region remains mired in a deep recession, with the gross domestic product (GDP) contracting by 4.4 percent year-on-year in the third quarter, following a whopping 14.8-percent decline in the second quarter. And this recessionary environment may persist for another quarter or two before positive growth is registered once more.
As such, loan demand in the eurozone should continue to be subdued for some time to come, as corporates further delay their investment plans and as businesses remain in survival mode. “Borrowing rates are supportive, but cannot fall much further, and bond markets are an attractive alternative for larger corporates in many eurozone countries,” noted ING Think in its Banks Outlook 2021 released in October, adding that those businesses seeking alternative sources of liquidity once those of government-supplied liquidity have dried up “may stimulate demand for bank loans, but only to a limited extent”. With Southern European economies being especially damaged by the pandemic and with such economies tending to have a higher proportion of small and medium-sized enterprises, moreover, the Dutch bank expects this particular sub-region to experience the sharpest weakening of bank-loan demand within the entire single-currency bloc.
Negative rates are also set to remain in place for the foreseeable future, which should, in turn, squeeze the net-interest margins of eurozone banks throughout 2021, if not beyond. Again, this is likely to impact Southern European countries such as Spain and Italy more intensely, as short-term loans constitute a high proportion of their balance sheets, and net-interest income represents a greater share of their overall revenues. Negative rates will also continue to hurt savers, with many banks passing the burden on to their customers. According to a study of 1,300 German banks by financial-product comparison portal Biallo, for instance, more than 300 are charging negative rates to at least some of their customers. And of those banks, nearly 200 are implementing negative rates on private customers.
And as moratoriums on debt repayments continue to reach expiration across eurozone countries, there is likely to be clear asset-quality problems throughout 2021, with bad debts mounting during the year. According to Elke König, chair of the Single Resolution Board (SRB), nonperforming loans (NPLs) in the region should continue to rise, thus putting a drag on banks’ balance sheets. That said, the chairperson of the Single Resolution Board of the Single Resolution Mechanism (SRM), which oversees the orderly resolution of failing banks within the European Union (EU), said she remains unsure as to when exactly the level of NPLs will ultimately peak. “I would have thought in the beginning [of the pandemic] in spring that we might see the first real impact on balance sheets in the third or fourth quarter of this year,” König told CNBC in November. “Until the dust has settled a bit, I would expect we will see it [a rise in NPLs] in the third and second quarters of next year…. Let’s be clear, this is a unique situation.”
Pablo Hernández de Cos, Spain’s central bank governor and a European monetary policymaker, similarly expressed his belief that banks’ NPL loan ratios are set to “increase significantly” over the coming quarters, even when factoring in more benign COVID-19 scenarios.
Such long-term problems may well result in greater consolidation activity throughout the eurozone. “There is plenty of scope for M&A [mergers and acquisitions] in most countries without raising competition issues,” noted S&P Global Ratings, whilst also acknowledging the increased support for consolidation among policymakers. “Regulators appear more concerned by the sustainability of banks’ business models than too-big-to-fail concerns.”
Indeed, Pablo Hernández de Cos voiced his support for cross-border banking consolidation within the region as a way to strengthen the European banking union and boost geographical diversification among lenders. “European transnational operations would be particularly positive and would also foster a potential bigger client base to share the burden of technological investments,” de Cos said in late October.
Most consolidation will take the form of domestic deals, according to ING, while larger banks are more likely to be involved in cross-border deals targeting new markets as they face ever tougher competition from tech platforms. “Cross-border deals have been hindered partly by a reluctance of domestic authorities,” the bank said in late October. “The tone may be changing, though, with the ECB now seemingly pushing harder towards bank consolidation.” The European Central Bank (ECB) may also soon lower the refinancing rate on its targeted longer-term refinancing operations (TLTROs), which provide financing to credit institutions. “This will help banks’ profitability at a time when provisioning for nonperforming loans is mounting,” noted S&P.
Banks in European emerging markets, meanwhile, are likely to face perhaps the strongest headwinds of all in 2021. “Across the Commonwealth of Independent States, large loan impairments will increase because of the double economic shock of the pandemic and oil price slump,” Moody’s Investors Service warned in early December. “Pressure on fundamentals will also carry over to Central and Eastern European banks, but economies contracted more mildly than European Union peers and are set for a stronger recovery in 2021.”
Will there be a wave of bank failures across the eurozone in 2021? Not likely, according to König. “Why am I mildly optimistic? The ECB did their [vulnerability] analysis, others did similar stress tests, they show that after the financial crisis, banks’ balance sheets have been cleaned up and beefed up [and] have more and better capital, so on average we can weather this kind of storm.”
S&P also stated that it expects the economy to recover strongly in 2021 with 6.1-percent growth, following a 7.1-percent total contraction for 2020. “Economies will recover at different speeds, with Germany leading the pack,” the ratings agency predicted, which should ease some of the pressure on banks in the region.
As far as the eurozone banking sector’s non-COVID-related outlook is concerned, arguably it’s the ECB’s heightened focus on climate risk that is the most significant. Many of the central bank’s most visible efforts in recent times have been to push the eurozone countries to step up their commitments to mitigating climate change. In late November, for instance, the bank published a report that found that banks are lagging behind on their climate-related and environmental risk disclosures. “While there has been some improvement since the previous year, banks need to make significant efforts to support their disclosure statements better with relevant quantitative and qualitative information. In the second half of 2021, the ECB intends to identify remaining gaps and discuss them with the banks.”
The ECB also published the final version of its guide on climate-related and environmental risks in late November, in which it explained how it expects banks to prudently manage and transparently disclose such risks under current prudential rules. The bank has pledged to follow up with banks in two main steps. In early 2021, it will first ask banks to conduct self-assessments in light of the supervisory expectations outlined in the guide and to draw up action plans on that basis. The central bank will then benchmark the banks’ self-assessments and plans and challenge them in the supervisory dialogue before conducting “a full supervisory review of banks’ practices and take concrete follow-up measures where needed” during the following year.
The future remains decidedly uncertain at this stage, as the pandemic continues to restrict economic activity not just throughout the eurozone but across much of the rest of the world. Perhaps equally as important as the implications for performance metrics, however, are the myriad of singular, unique consequences that COVID-19 will present to banks, such as the acceleration towards digital banking, new methods to deal with customers under possibly sustained social-distancing norms and ways banks manage employees coming back from one of the toughest years on record. And this would certainly seem to apply to Europe more than most other regions. According to a recent survey by Deloitte of 200 global banking executives, almost 60 percent of European respondents stated that employee fears of returning to work would hamper their ability to succeed after the pandemic, significantly more than respondents in North America (35 percent) and Asia-Pacific (38 percent).
“Banks will need to confront ongoing challenges from the pandemic and boost their resilience—whether it is capital, technology, or talent,” Deloitte’s recent “Banking and Capital Markets Outlook” for 2021 asserted. As such, eurozone banks will undoubtedly have a wide range of challenges to confront in 2021.