The ECB urges banks not to depend on rate hikes to improve their profitability

The risks of a bumpy exit from the low rate environment remain more current than ever

MADRID, 7 Jul. (EUROPA PRESS) -

The banking sector should not rely exclusively on expected rate hikes to improve its profitability and needs to address its structural problems, given the worsening macroeconomic outlook for the eurozone, which remains the risk of a "bumpy exit" from the low rates that have characterized the last decade, according to the president of the Supervisory Council of the European Central Bank (ECB), Andrea Enria.

"Banks cannot rely exclusively on the normalization of monetary policy to improve their profitability, they must address their structural problems," the Italian stressed in a speech delivered at an event organized in Frankfurt by the European Banking Federation.

As indicated last week, the banking supervisor has recommended that entities review their capital trajectories to include the risk of recession in their macroeconomic scenarios and take these updates into account in their distribution plans.

In this regard, Enria acknowledged that as a result of the invasion of Ukraine, the macroeconomic perspectives have been constantly deteriorating and the gas supply crisis makes possible a scenario of total interruption of energy imports from Russia in the future, increasing the probability of adverse scenarios and tail risks materializing.

Thus, against a broadly positive first-quarter banking sector performance in terms of profitability, banks' market valuations have been falling since the start of the conflict in Ukraine and have shown no signs of recovery to date.

"In a base scenario of positive growth, a gradual increase in interest rates will be beneficial for banks in general, boosting profitability through interest margins," explained the Italian, who, however, has warned of that if rates were to rise in a context of economic recession, banks' profits would deteriorate.

Likewise, it has pointed out that, regardless of whether a recession occurs or not, the interaction between monetary policy adjustments, inflation dynamics and market expectations could lead to very pronounced or disorderly increases in market interest rates. above those used in the supervisor's assessment of bank balance sheets, widening credit spreads as a reflection of greater risk aversion.

"Such disorderly scenarios could, in aggregate, be detrimental to banks' balance sheets and depress their profitability through transmission channels similar to those that play out during a recession," Enria explained, adding that they could also have knock-on effects, particularly harmful in specific pockets of vulnerability.

"The risks of an abrupt exit from the low interest rate environment that has characterized the last decade remain more current than ever," he warned, stressing the need to focus on certain business areas, such as leveraged finance, exposures to non-bank financial institutions and counterparty credit risk.