09 February 2023

S&P: Eurozone banks braced for liquidity, revenue hit as cheap funding era ends

Eurozone lenders face holes in interest income, reduced liquidity and higher deposit and financing costs as the end of the ultra-cheap money era begins to bite.

Fourth-quarter earnings show the first evidence of the effects of the European Central Bank's decision in October to hasten repayments due under its €2.2 trillion stimulus program, known as the third targeted longer-term refinancing operation, or TLTRO III. Final repayments are due in December 2024, to align with its efforts to tighten monetary policy.

TLTRO III was used to stimulate lending to the real economy in response to the COVID-19 pandemic, and has provided banks with a range of benefits. Many deposited unused TLTRO III funds at the ECB at higher rates than at which they borrowed in what is known as a carry trade, enabling them to earn hundreds of millions of euros per quarter of extra income.

"One of the biggest impacts of the end of TLTRO is that this benefit will disappear," Nicolas Hardy, deputy head of financial institutions at Scope Ratings, said in an interview.

Revenue headwinds

"TLTRO will have a negative impact in the first three quarters and less in the fourth quarter," said Leopoldo Alvear, CFO of Spain's Banco de Sabadell SA, one of the first eurozone banks to report fourth-quarter earnings.

French banks may struggle to make up the difference. Deposit costs at Gallic lenders are rising rapidly due to inflation-linked increases on the rates offered by regulated savings schemes such as the Livret A. Regulatory limits on the pace at which rising interest rates can be passed on to new mortgage loans, known as the usury rate, and the fact that French banks' mortgage portfolios are largely fixed-rate for long terms, puts further pressure on French lenders' NII.

French credit institutions received the largest proportion of ECB funding in the bloc, data from the central bank and credit rating agency DBRS Morningstar shows.

"[The end of TLTRO III] is somewhat of a headwind for French banks," said Arnaud Journois, vice president, financial institutions at DBRS Morningstar. "They won't benefit as much from higher interest rates as banks in other countries."

Most other eurozone banks should be able to more than offset losses with increases to net interest income — the difference between interest income and interest expenses — thanks to rising interest rates.

Many of the bloc's banks will in fourth-quarter results book large one-off losses associated with the changes to the terms of TLTRO III. Dutch lender ING Groep NV took a €315 million hit from the unwinding of derivatives taken out against its projected income on the original terms of the scheme.

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