Will the September hike in the deposit facility rate impact the European banking space? Maybe, maybe not…
By Jérémie Boudinet, Head of Investment Grade Credit, La Française AM
The deposit facility rate is one of the three interest rates the European central bank (ECB) sets every six weeks as part of its monetary policy. The rate defines the interest banks receive for depositing money with the central bank overnight. Since June 2014 and until July 2022, this rate was negative and weighed on banks’ profitability. A so-called “two-tier system” was introduced in September 2019, which exempts part of credit institutions’ excess liquidity holdings from negative remuneration at the rate applicable on the deposit facility. The purpose of this system was to alleviate the impact on their profitability. Following the hike of the deposit facility rate to 0.75% in September 2022, the two-tier system for the remuneration of excess reserves was removed. With the ECB set to pursue further rate hikes in its coming meetings, could we expect further positive profitability impacts on European banks and repercussions on the bank subordinated debt space?
In short: not really in our opinion. Yes, higher rates usually translate into higher net interest revenues, as banks can increase their margins. Higher profitability metrics for banks would however not necessarily translate into thicker solvency capital ratios, as banks may be tempted to increase shareholder remuneration instead. Solvency buffers kept by banks are influenced by regulators and are unlikely to evolve much in the coming quarters, in our opinion, and should stay elevated in any case to avoid any systemic risk arising in Europe. It is worth noting that several national regulators (among which are French and Swedish regulatory bodies) are set to increase capital requirements next year for their local banks via the “countercyclical buffer” component. This buffer is intended to protect the banking sector from periods of excess aggregate credit growth but is currently being hijacked by regulators to deter banks from returning significantly more capital to their shareholders.
Higher rates are only a fraction of the profitability/solvency equation for European banks, because theyoperate in an over-regulated sector; over-regulation being good news for bondholders, but less so for shareholders. Moreover, the banking sector is very prone to government meddling, with several recent examples: (i) The French government forcing local banks not to raise fees by more than 2% in 2023, (ii) a new bank tax approved in Spain, (iii) Polish ruling party leader Kaczynski wanting Polish state banks to raise interest on deposits to “at least 7-8%”. Banks are an easy target for politicians, and the benefits of higher rates can easily be wiped out by non-recurring caps, taxes and regulatory impediments.
Higher rates are positive for profitability only as long as the other metrics remain consistent, which is not a given amid such macroeconomic uncertainty. Bank profitability is dependent on the bank’s ability to produce new loans, on the level of loan loss provisions required to protect its balance sheet against a recession and on the cost of its wholesale funding, which has increased in 2022. The banking sector is and will remain cyclical and a proxy for macroeconomic sentiment. Higher interest rates are positive in the long run for the European banking sector, but profitability and solvency metrics will stay geared to regulatory, political and macroeconomic decisions. As such, we do not expect any impact on subordinated bonds from higher rates.
The information provided is considered well-founded and accurate on the date of publication. The information reflects the opinions of La Française AM. This publication has no contractual value, and its contents are subject to change. The opinions may differ from those of other management professionals. Published by La Française AM FINANCE Services, whose registered office is at 128, boulevard Raspail, 75006 Paris, France, and which is regulated as an investment services provider by ACPR (“Autorité de contrôle prudentiel et de résolution”) under no. 18673. La Française Asset Management was approved by the AMF under no. GP97076 on 1 July 1997.