The persistently low interest rate environment is likely to pressure profits at Europe’s banks, says DBRS Ratings Ltd. in a report published on Friday.
Amid continued weak economic conditions, it’s expected that European policymakers will keep rates low for longer, and the Toronto-based rating agency expects this scenario to increasingly pressure the region’s banks, impacting both earnings and internal capital generation.
“With weak economic growth and heightened uncertainty, especially following the recent vote in favour of the U.K. leaving the European Union (Brexit), the period of ultra-low interest rates within Europe is likely to be prolonged, especially now that negative interest rates have been introduced by some central banks across Europe,” the DBRS report says.
So far, the region’s banks have dealt with the low rate environment in a number of ways. For example, earnings for some banks have benefited from improving credit quality and lower provisions.
“Many banks have also managed to lower their funding costs to offset declining yields on loans and other assets, while also achieving expense savings, expanding their non-interest income generation and deleveraging non-core assets,” the report adds.
Yet, as ultra-low rates last longer, the effectiveness of the measures that banks have used to date “is likely to be constrained, resulting in increasing earnings pressure,” the report says.
“This could negatively impact European bank credit fundamentals,” the report says, “especially at a time when regulatory demands, in the form of new market, credit and operational risk requirements, are already putting a heavier burden on banks.”
Banks may end up taking on more risk, or reducing lending, the report suggests.