The results of the latest stress tests for European banks highlight the risks posed by higher interest rates amid economic stress, Fitch Ratings says in a new report.
The rating agency said the European Banking Authority’s latest stress testing exercise reveals the fundamental challenges that banks would face from still-higher rates on their funding positions and their core banking businesses.
“The results clearly demonstrate the risks from further upward interest rate shocks and increased funding costs,” Fitch said.
“This particularly affects banks with large volumes of long-dated unhedged fixed-rate assets on their balance sheets.”
The combination of higher funding costs and rising credit losses “would put significant pressure on banks’ earnings,” the report said, adding that this would, “leave capital ratios more vulnerable to depletion.”
In particular, banks that face weaker net interest income under the stress tests’ adverse scenario are expected to face greater pressure on their capital.
Under the stress tests’ adverse scenario, net interest income is projected to fall by 19% “as higher funding costs outpace higher lending margins,” Fitch said.
Over a three-year period, aggregate net interest income is projected to be 21% lower under the EBA’s adverse scenario versus the stress tests’ baseline scenario.
However, under the EBA’s baseline scenario, the stress tests showed that higher interest rates have been positive for banks’ earnings in 2023, Fitch said. The earnings reports for the first half of 2023 indicate that, for many banks, net income has benefited even more from higher rates than the EBA’s tests imply.
“Banks with high proportions of variable-rate lending, notably in Greece, Portugal and Spain, have benefitted most from higher interest rates,” it said, adding that net interest income has risen for most banks “as pass-through rates on deposits are yet to increase significantly.”