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What would you say to those who think that banks are making excessive profits?
The ECB’s latest Financial Stability Review, which has just been published, indeed shows that bank profitability has risen sharply. This improvement can be attributed to the widening of interest rate margins. The return on equity of euro area banks now stands at around 10%, whereas in 2019, barely five years ago, it stood at 4%. So it has clearly improved.
Still, this is something of an illusion − it is after all a short-term improvement. In the long term, we expect profitability to fall again. Why? There are several factors. First, the economy is slowing, which will lead to higher default rates and a decline in asset quality. Second, banks will have to pay more to attract deposits. On term accounts, for example, interest rates have already risen sharply. Likewise, the bonds that banks issue themselves will need to carry a higher return. So overall the cost of bank funding is on the rise. And finally, an often-overlooked factor is that demand for credit is falling. Putting all that together, you can see that high bank profitability is not sustainable. In fact, the financial markets are already convinced of this, as bank share valuations are in no way reflecting expectations of high profits.
Are the banks sufficiently covered for interest rate risks. If not, could the regulator, the ECB, review its requirements?
The interest rate risk of European banks can’t be compared to that run by some US banks such as Silicon Valley Bank with a different business model. The repricing of loans, in other words, raising interest rates in line with the market rate, has been much faster than the repricing of deposits in Europe. However, the interest rates on deposits will also increase at some point.
So is interest rate risk adequately covered?
Yes, but at the same time banks will be facing a loss of profitability as I said. I am talking about the average for the sector.
There has been a lot of debate about interest rates on savings. Politicians are taking initiatives to get banks to raise interest rates. Is that a good idea?
If the ECB raises interest rates, it is for borrowers and savers. Lending rates have risen and the remuneration of deposits is expected to follow suit. The remuneration on savings accounts should reflect our interest rates. That is part of our monetary policy transmission. Because if savings become more attractive, consumers will spend less, reducing demand. This is what we aim for to push down inflation. However, we now see banks are delaying passing on higher interest rates to savers. They can do that because they still benefit from abundant liquidity right now. But we are also taking measures to reduce excess liquidity, so that higher interest rates on savings accounts will become a reality – sooner or later...
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