European banks will enter 2022 generally well positioned to withstand the unwinding of pandemic-era support measures, thanks in part to a healthy capital surplus, ratings agencies have said.
European banks were already well capitalised going into the pandemic, and the sector's capital strength has grown through the crisis as buffers went unused and distributions were restricted.
The European banking system boasted an average CET1 ratio of 15.5% as of the end of the first half of 2021, up from 14.7% a year previously, according to the European Banking Authority's annual risk assessment.
Ratings agencies expect capital ratios to decrease as banks resume dividend payments and share buybacks over the coming quarters, but said buffers will still significantly exceed banks' requirements.
That means banks are seen as well positioned to withstand a deterioration of asset quality associated with the pandemic.
Fears of a widespread rise in problem loans as economies were shuttered for long stretches of 2020 and 2021 failed to materialise, thanks to support measures rolled out by governments.
The phasing out of those measures is expected to eventually result in a deterioration of asset quality. Moody's noted that the proportion of IFRS 9 Stage 2 loans – defined as a loan for which the credit risk has increased significantly – has increased by 30% since 2019.
However, ratings agencies expect the rise to be gradual and manageable.
"Regulators will reimpose capital buffers taking into account economic, market and bank-specific conditions," said Moody's. "Due to the usual 12-month implementation lag, changes will not take effect until the end of 2022 at the earliest."
European banks' long struggle with profitability is expected to continue, although Fitch noted the banking sector's revenues rebounded in 2021.
"Supportive capital markets trends provided a cyclical boost to revenue from corporate and investment banking and asset and wealth management in 2021," it said.
"Retail banking also performs decently despite tight net interest margins. However, the revenue momentum of 1H21 slowed in 3Q21, which is expected to continue as tailwinds expire."
Expected rate rises next year are also set to be beneficial for banks' profitability, although the impact may not be uniform as central banks potentially take different approaches.
European banks still have much to do to increase profitability to at least match costs of capital while adapting to digitalisation trends and fighting off competition from fintech rivals, noted S&P.
"Investment, cost-cutting, exiting non-core businesses, domestic consolidation, and fee income generation are all areas in focus," said S&P. "Even so, we expect average RoE for the top 100 European banks to rise to only 5.9% from 5.4% in 2021."
Fitch added that it expects banks to continue to announce cost-cutting initiatives next year, but noted these may be challenged by inflationary pressures and increased regulatory costs.