People examining economic statistic Financial examiner Vector illustration.

The European banking sector is struggling to improve profitability, and market risk remains elevated, according to a new report from the European Banking Authority (EBA).

The EBA issued a report on Thursday that sets out the main risks and vulnerabilities facing the region’s banking sector. In particular, it said that bank profits remains an issue.

“Banks’ return on equity is in many cases still below their cost of equity, which might also indicate that certain business models are not sustainable,” it said.

Moreover, it noted that the weak profitability persists even in a positive macroeconomic environment that ordinarily supports growing profits.

“In case of a slowdown in economic growth, banks’ revenues might come under further pressure,” the report said.

“This would add to increasing competitive pressure, including from incumbents and fintechs, and might be accompanied by potentially growing cost of risks and deteriorating asset quality.”

Indeed, the report indicated that only about 25% of banks expect an improvement to profits in the next six to 12 months.

The EBA said market risks remain elevated too.

“In a deteriorating economic outlook and in case of materialising political event risk, market risk might [quickly] come to the fore, leading to potentially high volatility — including on FX markets — and sharp asset repricing,” it said.

Additionally, a sudden contraction in financial market liquidity might add to these risks, it said.

On the upside, European banks’ capital ratios remain strong, the report said, adding that the quality of banks’ loan portfolios continues to improve too.

“Nonetheless, banks and analysts are now more pessimistic in respect of future trends in asset quality,” it said. “Respondents are particularly concerned about the possible deterioration of corporate and commercial real estate exposures.”