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General state of the European banking system in the current
macroeconomic and geopolitical environment
Russia’s invasion of Ukraine,
which has developed into a widespread macroeconomic shock, has not yet
produced visible balance sheet damage, and both banks and analysts seem to be
looking at the near term with optimism. At an aggregated level, the Common
Equity Tier 1 (CET1) capital ratio of significant institutions stood at 15% in the
second quarter of 2022, while the liquidity coverage ratio stood at 164.4%, well
above pre-pandemic levels. Thanks in particular to sales, securitisations and
write-offs, the headline NPL ratio continued to decrease in the second quarter of
this year to reach 1.8%. The post-pandemic economic rebound coupled with the
beneficial impact of rising rates on margins have supported banks’ profitability
over the last few quarters. In fact, in the second quarter of 2022 the return on
equity of significant institutions reached 7.6%. As of this summer, listed banks and
analysts alike are projecting that the 2023 return on equity will remain broadly
stable at 2022 levels or that it will improve.
However, owing to the war in Ukraine, the macroeconomic outlook has been
continuously deteriorating and financial markets have proven particularly
sensitive to abrupt adjustments in asset prices and interest rates and prone
to dislocation episodes not necessarily linked to fundamentals.
In my view, these two types of dynamics require both banks and supervisors to remain very vigilant and prudent when looking at banks’ near-term performance. Although the war, the sanctions against Russia and the latter’s retaliation measures have so far had a limited direct impact on banks, the macroeconomic repercussions of this geopolitical crisis are starting to be felt across the euro area. The September 2022 ECB staff projections pointed towards yet another deterioration in growth under the baseline and downside scenarios accompanied by high inflation. Under the downside scenario, the projections suggest negative growth (-0.9%) for real GDP in 2023. On 26 September the ECB flagged that a recession in the euro area is becoming more likely as some of the assumptions behind the downside scenario are starting to materialise. In addition, the ongoing energy crisis is further exacerbating the pre-existing inflationary pressures driven by pandemic-related supply chain bottlenecks. As a response to rising prices, monetary policy efforts are focused on bringing inflation back to levels consistent with price stability. In this type of environment, substantially different from the one at the start of the COVID-19 pandemic, it is becoming increasingly clear that potential fiscal support interventions ought to remain well targeted and carefully calibrated to be compatible with the fight against inflation.
On financial markets, heightened uncertainty and volatility have put specific market segments under strain. Volatile energy and commodity prices have resulted in utility companies, commodity traders and other non-financial corporates using energy and commodity-related derivatives as hedges to deal with extraordinary spikes in margin calls. In the United Kingdom, sharp upward adjustments in gilt yields in response to the Government’s economic policy announcements have led to pension funds and their liability-driven investment strategies being faced with severe spikes in margin calls, threatening fire-sale spirals on gilts and prompting the Bank of England to intervene with very material public debt purchases. In the event of abrupt stock price or other asset price adjustments, events such as the 2020 default of the private equity firm Archegos cannot be ruled out. The opaqueness of leverage and risk-taking at non-bank financial institutions raises concerns about the potential impact on banks through unexpected channels of contagion.