In-depth Analysis

Banking stocks thrive in the high interest-rate environment 

It has been a good earnings season for major banks with Deutsche Bank, Barclays, Santander, HSBC, Standard Chartered and UniCredit all reporting better-than-expected results with an increase in revenue ranging between 8% and 9%.

This series of strong earnings come on top of a successful previous quarter as the rising interest rate environment continues to work in favour of major banks. In the second quarter, European banks posted revenue growth of 8%, driven by a 14% increase in net interest income.

Normally rising interest rates tend to dampen business, but this is not the case for banks which benefit from the difference between what they charge borrowers for loans and what they pay savers on their deposits. During the latest quarter, this difference has gone up, on average, to about 2.9% from around 2.5% in the previous quarter.

What is also positive for the banks is that they are coming into this inflationary environment with much cleaner balance sheets than during the previous financial crisis, they have put in place significant provisions and are working in an environment where governments are promising to put in place support packages for households and corporates designed to help with rising costs.

Deutsche Bank leads the pack

The effects are already visible in the results published over the course of the last two weeks. Germany’s largest lender Deutsche bank reported a 4.1% year-on-year increase in revenue but its net profit margin rose 42% year on year. Some banking shares are comfortably outperforming local indices like in the case of Deutsche Bank. DB’s shares have risen by nearly 25% over the last 30 days while the DAX went up 7.8%. BNP Paribas is trading up 8.9% on the month and UBS 6.8%.

The aberration are several UK banks like Lloyds and Natwest which have on the surface reported a loss, but which have actually made a profit on the same scale as other major European banks but have put in much higher loan loss provisions than their peers. This will only become a loss if there is a high level of defaults on loans and mortgages over the coming months. We would argue that the banks have gone deliberately high on those provisions.

In the spring of 2021, after the first year of Covid, UK banks released millions from their loan loss provisions because the level of defaults proved much lower than they assumed.

Months ahead

High-interest rates are far from over, especially in Europe. While there is talk of the Fed raising rates just a few more times before inflation peaks the Eurozone and the UK are trailing behind that trajectory. The ECB has increased rates by 0.75% this week and there is clearly more to come in the new year.

Under the current interest rate scenario banking profits are set to remain strong and banking shares, which had not received much attention earlier this year, are beginning to look like a much safer bet.

 

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