European banks are approaching peak profitability as risks build, says Morningstar
Morningstar’s latest European Banks Industry Pulse finds that European banks are approaching peak profitability. While renewed energy-price-driven inflation has increased expectations for higher interest rates, it has also raised risks to economic growth and credit quality. Higher rates may continue to support margins in the short term, but Morningstar sees limited upside across the sector, with developments increasingly tracking towards its downside scenario.
Niklas Kammer, senior equity analyst at Morningstar, said: “European banks have enjoyed a prolonged earnings tailwind from higher interest rates, but we believe the sector is approaching peak profitability. Structural hedges and wider deposit margins should continue to support earnings in the near term, yet much of that benefit now appears reflected in valuations.
“Looking ahead, the balance of risks is becoming less favourable. If elevated energy prices keep inflation higher for longer, further rate increases could put additional pressure on economic growth, slowing loan demand and increasing the risk of credit losses. While the sector remains well capitalised and fundamentals are sound, we think investors will need to be more selective in where they find value.”
Key findings include:
European banks are nearing peak profitability. Valuations look modestly expensive, increasing the importance of capital distributions and operating efficiency for future returns.
Structural hedges could support earnings until 2031. Higher swap rates are expected to boost net interest income until at least 2027, with more modest gains possible through 2031.
Higher rates are weighing on the lending outlook. Eurozone and UK mortgage demand is expected to soften, while eurozone corporate loan demand remains flat and consumer credit conditions are tightening.
Credit quality remains sound, but risks are building. Unemployment is edging higher, with Morningstar viewing corporate loan books as more vulnerable than household lending.
Investment banking revenues face tougher comparisons. Fixed-income and equities trading continue to support revenues, with third-quarter performance pointing towards a slight year-on-year increase.
Morningstar’s preferred picks: BNP Paribas and NatWest Group.
