Emmanuel Laborde: After a long and unfavourable period of low rates, almost six years, European banks overall have seen their interest margins and profitability increase when ECB's rates rose in 2022 and in 2023.
Emmanuel Laborde: Hello.
Laurent Quignon: Hello.
Emmanuel Laborde: We're entering a phase of rate cuts. What will be the impact on the interest margins of European banks?
Laurent Quignon: There's no clear answer. In banking systems with fixed-rate loans like in France, Germany or Belgium, this decrease causes a reduction in the cost of banking resources. This phenomenon is intensified by a decline in customers’trade-offs toward more costly saving products. The return on bank assets remains rather stable in the absence of massive renegotiations. In contrast, banking systems relying on variable rate loans like in Italy, Spain or Portugal which have seen a significant increase in their margin interests when the rates increased in 2023 should see these margins contract during the revision of loan contracts. But it would remain at a level superior to what prevailed when the rates were low.
Emmanuel Laborde: Beyond the structure of fixed or variable rates, are there other factors that could attenuate the sensitivity of banking systems to variations?
Laurent Quignon: Besides hedging strategies, a greater diversification of activities, or geographical diversification, and a larger proportion of fees in the total income are factors likely to attenuate the effects of rate variation on banks' incomes.
Emmanuel Laborde: Does the method of financing, fixed or variable rates, affect the evolution of cost of risk?
Laurent Quignon: Yes. In systems with variable rates, decrease will benefit all the borrowers. In systems with fixed rates, it will only benefit the recent borrowers and not the current borrowers. Renegotiations are possible of course but they will be interesting only for a very small part of the borrowers.
That being said, we must bear in mind that, in banking systems with fixed rates, interest charges did not follow the increase in rates in 2022 and in 2023. Being at a very low level, the cost of risk had only slightly increased.
Emmanuel Laborde: So, the decrease in rates should continue. In this context, what will happen to banks' profitability in the months to come?
Laurent Quignon: In average, for European banks, the negative impact of decreasing interest rates on bank interest margins should be partially offset by a positive volume effect. According to the last ECB's survey, the banks notice a strong rebound in housing loans demand and a moderate recovery in demand from firms for loans for the first time in two years. That's encouraging. But we could still see a dichotomy according to the financing model: fixed rates or variable rates.
The banks which mostly own fixed rates portfolios, like French banks, should better succeed compared to their rivals from Southern Europe. Besides, they own most diversified business portfolios, which go far beyond retail banking. And the decrease in interest rates should sustain fees coming from other activities.
Emmanuel Laborde: Thanks a lot for this insight. For our next topic, we're going to China.
