European banks collectively surged to a 15.9% CET1 ratio, a key indicator, and an enhanced return on equity of 10.8% at the end of June.

The figures were published by the European Banking Authority in its Q2 2023 quarterly risk dashboard on Tuesday 10 October 2023.

Capitalisation and profitability

Despite the ongoing macroeconomic turmoil, EU/EEA banks showcased notable fortitude in their capitalisation levels during Q2 2023. The fully loaded common equity tier 1 (CET1) ratio demonstrated an upward trend, increasing by 20 basis points and achieving a historical peak of 15.9%. Luxembourg recorded the second highest CET1 ratio of 22.52%, just behind Estonia at 23.16%.

This improvement, according to the 53-page , was propelled by a rise in capital, attributed to robust profitability. Nonetheless, risk-weighted assets experienced a marginal escalation, predominantly spurred by a rise in credit risk, while the banks’ leverage ratio steadfastly remained at 5.6% as of March 2023.

Liquidity

In addressing liquidity metrics, the EBA noted that the liquidity coverage ratio experienced a normalisation from 162.8% to 159.9% quarter on quarter, driven by the repayment of the targeted longer-term refinancing operations (TLTRO) III in June 2023. Additionally, the net stable funding ratio increased to 126.5%, up from 125.9% in Q1 2023.

Loans

However, the stability in certain financial metrics did not shield banks from challenges in loan growth, said the EBA. The outstanding loans to households and non-financial corporates remained stagnant on a quarterly basis amidst slower economic growth and an undercurrent of robust, yet potentially deteriorating, asset quality in some portfolios.

This stagnation in loan growth did not inhibit a further enhancement in return on equity, which, as cited by the EBA, escalated to 10.8% in Q2, up from 10.2% in Q1 2023, primarily driven by an increase in net interest income. In a year-over-year comparison, return on equity burgeoned by approximately 300 basis points. The average cost-to-income ratio saw a decrement from 59.5% to 56.5%, marking the lowest level, as banks adeptly managed their expense inflation.

Interest income

The EBA reported a 20% annual and 2.5% quarterly ascent in net interest income, with banks’ net interest margin experiencing a rise from 1.3% to 1.6% year on year. Nevertheless, the report noted a deceleration in the quarterly growth rate of net interest margin compared to preceding quarters, partly attributed to escalating funding costs anticipated to be subject to further pressure in future periods.

The EBA pointed out the disparity in the benefits accrued from higher interest rates by various banks, which was influenced by factors such as the structure of their balance sheet and the composition of fixed vs variable interest rate loans, alongside the proportion of debt securities and deposits to total liabilities.

Mrel compliance

The EBA’s findings indicated a minor minimum requirement for own funds and eligible liabilities (Mrel) shortfall at the EU/EEA level, albeit with significant variation among nations. As of Q1 2023, the external Mrel shortfall amounted to approximately €40bn, averaging 0.5% of total risk-weighted assets. Most banks are mandated to comply with Mrel by 1 January 2024, though some have been granted an extended deadline under the bank recovery and resolution directive (BRRD).

Asset quality

Regarding asset quality, the EBA highlighted that while the non-performing loans (NPL) ratio remained steady at its lowest of 1.8%, with stage 2 loans allocation stable at 9.1%, certain jurisdictions reported increments in NPL volumes. Moreover, some portfolios, especially those sensitive to rising interest rates like consumer credit and real estate exposures, could potentially witness an expedited deterioration.

Operational risks

Lastly, the EBA drew attention to operational risks, citing that 143 serious deficiencies in anti-money laundering related to 57 institutions were reported between June and August 2023 by competent authorities through the EBA’s Eureca data. These operational risks were further exemplified by a report of 50 ‘corrective measures’, with the majority of deficiencies pertaining to credit institutions. The most substantial weaknesses related to institutions’ customer due diligence policies and procedures, notably in transaction monitoring approaches.

The data compiled by the EBA encompasses a sample from 164 banks, accounting for over 80% of the EU/EEA banking sector’s total assets. This includes six banks from Luxembourg: Spuerkeess, Banque Internationale à Luxembourg, BGL BNP Paribas, Quintet Private Bank, RBC Investor Services Bank and Société Générale Luxembourg.