European banks are on track to deliver solid earnings and maintain robust capital levels over 2024-2025. Most participants at S&P Global Ratings' European financial institutions conferences in London (Sept. 26), Paris (Oct. 3), and Frankfurt (Oct. 8) agreed that the sector coped remarkably well from last year's volatility arising from the liquidity crunch in the U.S. and the demise of Credit Suisse.

Across the three conferences, around 500 participants heard speakers from the European banking industry provide insights on the European macroeconomic environment, banks' prospects, risk management, regulation, prospects for M&A, and the growing role of private credit.

Supportive Macroeconomic And Credit Conditions Continue

Most panelists and speakers in London, Paris, and Frankfurt were sanguine about European banks' near-term prospects, not least due to supportive macroeconomic factors and sector dynamics. Europe's economic growth is likely in the foothills of a "gradual recovery after a soft landing," said S&P Global Ratings' European Chief Economist, Sylvain Broyer.

We forecast eurozone GDP growth of 1.3% in 2025, up from 0.8% in 2024, notably supported by stronger consumer demand. Headline inflation is expected to fall to about 2% by the second half of 2025, down from 2.2%, with lower energy prices contributing significantly to the decline. Those conditions underpin our forecast of European Central Bank (ECB) benchmark interest rate cuts of 25 basis points (bps) a quarter to 2.5%, likely by September 2025.

Our London conference heard a similar view from keynote bank speaker Katie Murray, CFO of NatWest Group. In a U.K. context, Ms. Murray noted that rising consumer confidence, ample household savings, and falling rates could set the stage for a faster-than-expected economic rebound.

Conference participants and attendees remain wary of downside risks that could knock European banks off course. They include weaker-than-expected economic growth that weighs on labor markets, increased risk-taking by banks seeking to offset declining earnings growth, and financial instability due to market volatility. Conference attendees viewed subdued economic growth and fiscal constraints as the key challenge for banks (see chart 1).

Chart 1

Bank Performance Should Remain Robust, Even As Rates Fall

Considering European banks' generally solid profitability, sound liquidity, robust capitalization, and recent improvements to risk management, all but the most skeptical would be hard-pressed to see the glass as half empty. That optimism should endure, at least over the short term, even as central banks' policy rates fall, with slow growth and a benign macroeconomic outlook for Europe through 2025 providing support for banks' performance.

Two of our keynote speakers--Nicolas Namias, CEO of BPCE, and Jonas Ahlström, incoming COO and deputy CEO of SEB--explained some of the key aspects underpinning the expected continuation of European banks' improved performance. Mr. Namias lauded French banking's universal model for its revenue diversity, which is a strength. He also noted that in 2023 banks in the EU periphery (Spain, Portugal, Italy) led earnings growth, while French banks' earnings would benefit from the repricing of rates this year.

Mr. Ahlström underlined how consistent delivery of a multi-year business strategy can achieve organic growth and solid risk-adjusted returns over time. Starting from its initial home market in the Nordics, SEB has gradually expanded its presence in Europe and now considers the Baltics, Germany, and the U.K. as additional home markets. Mr. Ahlström explained that SEB's expansion was achieved by distributing exportable financial products in a cost-controlled manner, using efficient service and booking models.

European Banks Are Closing The Gap To The U.S.

Keynote speaker at our Paris conference, Chad Leat, Chairman of CCF Group, was keen to dispel some "myths" surrounding European bank performance relative to U.S. banks. He presented data showing that while the EU banking sector has historically posted structurally-lower earnings, compared to the U.S., that gap had narrowed, to 50bps as of the third quarter of 2023. He also highlighted that cost-to-income ratio of the eurozone's systemically important banks (G-SIBs) is converging to the level of U.S. G-SIBs, at around 64%.

We expect European banks' credit quality will continue to benefit from strong balance sheets, growing confidence in the sector, and improvements to banks' risk management practices. We forecast average ROE for rated banks will fall to 9% in 2025, from a median of 10% over 2023-2024, primarily due to declining interest rates. These headline ROE figures mask some stark regional differences, however, with French and German banks likely to remain laggards.

S&P Global Ratings European banking sector leads Nicolas Charnay and Giles Edwards also noted that the banks most exposed to downside risks (see chart 1) share certain characteristics. They include a narrow lending focus, higher exposure to unsecured retail and small business loans, more rate-sensitive earnings, weaker management of interest rate risk, and operational challenges--including poor efficiency, a weak competitive position, or major restructuring needs.

Our ratings outlooks on the largest 100 European banks are predominantly stable, with upgrade potential concentrated almost entirely on the 'BBB' and 'BB' categories (see chart 2).

Chart 2

Across the global universe of rated banks, Europe has the highest positive net rating bias (see chart 3). This primarily reflects the still-improving fundamentals of European banks in markets like Spain, Portugal, Greece, Italy, and Cyprus.

Chart 3

Profitability is set to decline over 2025-2026, but it won't fall off a cliff (see chart 4). Performance differences across banks and countries will remain, with Portugal and Poland among those likely to record the highest weighted average return on average common equity among rated European banks over the next two years.

Over the longer term, European banks' credit profiles could benefit from several macro and industry factors. Those include a potential push toward further integration of EU financial services and further in-market consolidation. In contrast, ongoing low (though still positive) GDP growth in Europe, the escalation of regional conflicts, and fiscal challenges in larger EU member states, among other things, could throw a spanner in the works.

Chart 4

Liquidity Fragmentation Remains

Liquidity risk management is critical to banks, and when it goes wrong, it can go wrong very quickly. Yet access to information on bank liquidity from public disclosures can be limited, often amounting to only the information provided by liquidity coverage ratio (LCR) disclosures.

Panelists at the London conference discussed why adhering to the required LCR, which assesses banks' ability to meet their cash demands during a one-month liquidity crisis, isn't enough to ensure banks' financial stability. Effective liquidity risk management requires a granular, data-driven understanding of client behaviors and other key sensitivities. It should also include internal stress tests that cover a range of different scenarios and assess the links between liquidity and other risks. "The best regulations and ratios are useless when not supported by the right culture, governance, and risk management," the London conference was told.

Bank supervisors have prioritized liquidity risk since the turmoil of 2023, but standards continue to differ across jurisdictions. In Switzerland, for example, domestic systemically important banks must hold sufficient high-quality liquid assets to weather a 90-day crisis, compared with the 30-day threshold in the rest of Europe. Yet not everyone is a fan of stricter liquidity rules. One speaker considered tighter regulations "a terrible idea that targets micro behavior" and isn't beneficial for the banking sector as a whole.

Central banks' also play a key role in mitigating liquidity risk. Yet, as events in the U.S. last year showed, that role can be fleeting or even purely theoretical if banks and central banks are not well prepared. Shifting monetary policy is changing central banks' behavior--the ECB and the Bank of England (BOE) have indicated that they intend to maintain a stock of ample reserves in their banking systems, giving banks unconstrained access to central bank funding facilities as and when required. The efficacy of that approach will depend on both the ECB and BOE ensuring that banks are operationally prepared to access their facilities, and that there is no stigma attached to its use. On the latter point, attendees at our London conference believe that markets will adopt a nuanced view, for now (see chart 5).

Chart 5

Banks' Risk Management Is Improving

Recent challenges faced by European banks have tested, and often resulted in improvements to, risk management systems and financial resilience, noted Stéphane Landon, Chief Risk Officer (CRO) of Société Générale, and other panelists at our Paris and Frankfurt conferences. For example, the volatile market conditions during 2023 (following the failure of SVB and the demise of Credit Suisse) led many banks to refresh their approach to the management and monitoring of liquidity and interest rate risks. Panelists noted that risks due to market volatility remain high on the agenda, with potential catalysts being factors such as geopolitical events (with two wars in the region), a more fractured domestic political backdrop across Europe, and fiscal constraints from governments seeking to reduce budgetary deficits.

That said, Olivier Mouton, Senior Credit Analyst at OFI Asset Management and other panelists at our Paris conference noted that non-traditional risks are increasing. We see these as harder to factor into risk assessment and management, for example, due to the opacity of cyber security and artificial intelligence risks.

There was also a clear view that banks shouldn't be too self-congratulatory--our panelists in Frankfurt noted that much of the improvement in bank financial strength has been underpinned by accommodative fiscal and monetary policy that amounted to "a lot of public support" over recent years.

In Frankfurt, we polled the audience for views on whether bank risk management has improved. Over half of respondents (54%) were unsure, which is perhaps indicative of the difficulties for investors in assessing banks' internal governance mechanisms. Still, 41% took the view that risk management practices had improved, leaving only a minority (less than 5%) with the opposite view (see chart 6).

Chart 6

The Challenges Of Consolidation, And Alternative Routes To Growth

European bank consolidation was a consistent topic of conversation across the conferences, not least due to UniCredit's circling of Commerzbank. Panelists in Frankfurt were skeptical that deals might soon lead to the creation of pan-European retail banks, noting that cross-border synergies in Europe remained elusive, due in part to regional product differences.

Mr. Ahlström noted other challenges to cross-border acquisitions can be significant. They include the effort and risk of acquiring and turning around a low performing bank. In our view, this could be compounded by the risk of entering less familiar markets, whether in terms of geography, customer base, or banking segment.

The conferences also heard that hopes for a unified European capital market remained distant, with policymaker enthusiasm failing to translate into initiatives with material impact, so far. Capital markets union (CMU) could support European GDP growth by providing a deeper pool of funding for investment and by shifting the onus for business financing from banks to the markets, as is the case in the U.S.

The Frankfurt conference also heard how CMU could lead to greater divergence among European banks, strengthening some and subjecting other more "traditional players" to greater risk of disintermediation. That prospect may be a reason for political resistance to the CMU project in certain EU member states, which we see as the major barrier to a single European capital market and one that is unlikely to be resolved in the near future.

Bank Regulation And Supervision: Complacency Breeds Danger

Elizabeth McCaul, Member of the Supervisory Board at the ECB, told our Frankfurt conference that the European banking system is in far better shape today than ten years ago, with stronger capital, liquidity, and balance sheets contributing to banking system resilience. Ms. McCaul cautioned that accidents are more likely to happen when people get complacent, while crises often emerge from the shadows, with overlooked risks posing the greatest danger.

Ms. McCaul said she was particularly focused on the importance of liquidity risk management by banks, and was watching with interest the growth of non-bank financial institutions (NBFI) and private credit markets. On liquidity risk management, she highlighted that the ECB has learned lessons from the banking turmoil of March 2023, including the importance of banks' readiness to swiftly implement contingency and recovery measures, the need for supervisors to carry out holistic cross-risk analysis (that considers the interplay with interest rate risk in the banking book), and governance arrangements.

The ECB sees a need for increased supervisory scrutiny of banks' modeling of non-maturity deposits, as models are sometimes not based on solid economic evidence. Additionally, supervisors have asked banks to consider supplementary liquidity and funding risk indicators, such as survival period or concentration metrics, to capture residual risks not addressed by the LCR or the Net Stable Funding Ratio.

Ms. McCaul also noted the staggering growth of the NBFI sector, which she said had grown to €200 trillion in 2024, from €87 trillion in 2008. In addition, the private credit market accounts for €1.6 trillion of the global market and is experiencing significant growth. A key issue from a bank risk perspective is that banks play a significant role in leveraging and providing bridge loans to credit funds, yet supervisors lack a full picture of the level of exposure and correlations between NBFI balance sheets and bank lending arrangements. This highlights the need for harmonization and expansion of reporting requirements to provide greater visibility into the NBFI sector and to facilitate improved information sharing between authorities.

Ms. McCaul also defended strong banking regulation, claiming it had not reached inappropriate levels, and asserting that a strong supervisory framework attracts investment and increases shareholder value.

A reference to the text of Ms. McCaul's keynote address is provided in the "Related Research" section, below.

Mr. Namias told our Paris conference that differences between European banking models could be better incorporated into bank supervisors' assessments, noting that the diversity of revenues from the universal banking model prevalent in France is a net benefit for financial system stability and for bank customers. He also suggested that new regulatory or supervisory requirements for banks should take into account the specific effects on cooperative/mutual banks due to their important role in financing the economy in the long-run, including through downturns in the economic cycle.

Private Credit Pushes Deeper Into Banking

In his keynote presentation at our London conference, Huw van Steenis, vice-chair at Oliver Wyman, discussed the impact of continued growth in private credit on traditional banking. He highlighted specialty finance--which includes equipment leases, trade finance, and royalty agreements--as a new growth area for private credit. Oliver Wyman estimates this market to be worth $5.5 trillion in the U.S. alone. The addition of loans related to infrastructure, commercial real estate, and mortgages expand that market to $26 trillion.

Mr. van Steenis said private credit players are increasingly seeking secure access to these markets by partnering with banks rather than competing with them. He noted that loan distribution was the driving force behind the 14 partnerships between major banks and private credit firms in the last year, an increase from just two such deals in the previous year. Mr van Steenis suggested this amounts to a re-tranching of the banking system, with banks leaving the riskiest part of the lending market to private credit and retaining less risky lending for themselves. Some banks are also selling tranches of credit risk on their balance sheets via significant risk transfer (SRT) transactions.

The majority of conference attendees in London were wary of the rise of private credit, which they felt was a negative factor for overall banking system risk (see chart 7).

A reference to the slides presented by Mr Van Steenis is provided in the "External Research" section, below.

Chart 7

Appendix

Table 1

Writers: Paul Whitfield and Kathrin Schindler.

Related Research

• European Banks' Resolution Story Moves To The Next Chapter, Sept. 25, 2024
• Phasing Out Bank AT1--An Australian Solution To An Australian Dilemma, Sept, 19, 2024
• European Banks: Preparedness Is Key To Unlocking Central Bank Funding, Sept. 17, 2024
• U.K.'s Near-Final Bank Capital Rules Will Have A Modest Impact On Rated Banks, Sept. 12, 2024
• UniCredit's Purchase Of A Significant Stake In Commerzbank Could Pave The Way For A More Transformational Deal, Sept. 12, 2024
• European Banks Continue To Reap The Benefits Of Benign Credit Conditions, Sept. 3, 2024
• U.K. Banks Are Well Positioned For Sustained Strong Performance After First-Half Results, Aug. 8, 2024
• European Banks: Covered Bonds Are A Cheap, Stable Funding Source With Limited Side Effects, July 4. 2024
• The Role Of Bank AT1 Hybrid Capital One Year On From The 2023 Banking Turmoil, June 26, 2024
• 2023 Banking Turmoil: Global Regulators Reflect And React, June 26, 2024

European macroeconomic and credit conditions

• Credit Conditions Europe Q4 2024: Turn In Credit Cycle Won't Be Plain Sailing, Sept. 25, 2024
• Economic Research: Economic Outlook Eurozone Q4 2024: Consumer Spending To The Rescue, Sept. 24, 2024
• U.K. Economic Outlook Q4 2024: Disinflation And Rate Cuts Will Stimulate Growth, Sept. 23, 2024

External Research

• Speech by Elizabeth McCaul, Member of the Supervisory Board of the ECB, at the S&P European Financial Institutions Conference, Oct. 8, 2024 (www.bankingsupervision.europa.eu/press/speeches/date/2024/html/ssm.sp241008~55f0d2d2d6.en.html)
• Huw van Steenis, Private Credit-Impacts On Banks And Asset Managers, Oliver Wyman, Sept. 26, 2024 (www.oliverwyman.com/content/dam/oliver-wyman/v2/publications/2024/oct/private-credit-next-act-and-barbell.pdf)