Coverage: weekly note · Information to 1 July 2024
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TGB Weekly Research Note · 1 July 2024
Margins at euro area and EU banks were still rising in the first quarter of 2024, but the ECB's June rate cut, narrowing loan-deposit spreads and banks' own survey responses all point to compression from here.
The desk view
The latest margin data show no turn yet: the net interest margin of ECB-supervised significant institutions rose to 1.62% in the first quarter of 2024 from 1.48% a year earlier, and the EBA's EU/EEA measure widened by 3bp to 1.69%. The forward indicators point the other way. On 6 June 2024 the ECB cut its three key rates by 25 basis points, taking the deposit facility rate to 3.75% from 12 June. The ECB's May 2024 Financial Stability Review said loan-deposit spreads had started to decline and that banks are likely to see margins fall. In the April 2024 bank lending survey, banks moved from a net 40% reporting a positive margin effect from ECB rates to an expected net -19%. Our reading is that the first quarter of 2024 is better treated as the top of the margin cycle in the data than as a new plateau.
Margins were still widening in the first quarter
The latest supervisory data do not yet show margins falling. The aggregate net interest margin of significant institutions supervised by the ECB increased further to 1.62% in the first quarter of 2024, compared with 1.48% a year earlier, an increase of 14bp. By reference period, the ratio ran from 1.53% in the second quarter of 2023 to 1.56% in the third, 1.60% in the fourth and 1.62% in the first quarter of 2024. The increments have narrowed: the latest was 2bp, against 5bp between the first and second quarters of 2023. Net interest income rose by 8.7% year on year and the aggregated annualised return on equity reached 9.67%, up from 9.31% in the fourth quarter of 2023.
The EBA's wider EU/EEA sample tells the same story. Net interest margins further widened to 1.69% in the first quarter of 2024, up 3bp on the quarter, and return on equity was 10.6%. On the EBA's weighted-average measure, the margin stood at 1.39% in December 2022 and 1.55% in March 2023, so it has risen by 30bp since the end of 2022.
The aggregate also hides a split. The EBA's 25th percentile margin fell to 1.23% in March 2024 from 1.30% in September 2023, while the 75th percentile rose to 2.96% from 2.75%. At the lower end of the distribution, margins were already slipping before the ECB moved.
The turn is visible in spreads, funding and policy rates
The ECB's May 2024 Financial Stability Review said euro area bank profitability has likely peaked. It said profitability peaked in the second half of 2023, with the annualised quarterly return on equity of significant institutions falling to 7.6% in the fourth quarter of 2023 from 10.6% in the second quarter. Net interest income stagnated in the fourth quarter of 2023 after eight quarters of growth, amid early indications that margins might be narrowing. The ECB noted that margins typically trail loan-deposit spreads, which started to decline in the fourth quarter of 2023, and said this indicated that margins may follow.
Two features of the balance sheet make the turn mechanical. First, three-quarters of the increase in banks' interest income from loans can be linked to variable-rate loans, which become a headwind once reference rates fall; yields on liquid assets such as central bank reserves would also shrink quickly. Second, funding costs lag: banks' average cost of funds reached 2.6% in the fourth quarter of 2023, up 2 percentage points since the start of the hiking cycle, and the ECB said deposit costs on the outstanding stock could keep rising after short-term rates turn.
The policy turn has now started. On 6 June 2024 the ECB lowered its three key rates by 25 basis points after nine months of holding them steady, cutting the deposit facility rate to 3.75% with effect from 12 June 2024. It gave no commitment on the path, saying it would follow a data-dependent and meeting-by-meeting approach, and it expected inflation to stay above target well into next year. Retail pricing had already flattened before the cut: in April 2024 the composite cost of borrowing was unchanged at 5.18% for new corporate loans and 3.80% for house purchase, while the rate on new household term deposits fell 5bp to 3.11%.
Banks expect compression themselves
The banks' own survey answers point in the same direction. In the ECB's April 2024 bank lending survey, a net 40% of banks reported a positive impact of ECB rate decisions on their net interest margins over the past six months, but they expected a net -19% over the next six months, a swing of 59 points. For net interest income the balance moves from 38 to -21, and for overall profitability from 35 to -22.
The EBA's Spring 2024 Risk Assessment Questionnaire gives the same message for the wider EU/EEA sample. Asked how the interest rate environment would affect net interest income over the next 6 to 12 months, 55% of banks expected a decrease, against 22% expecting an increase and 21% expecting no change. On overall profitability, 41% expected a decrease. The ECB's review cited analyst expectations that the return on equity of listed banks would ease from 11% to 10.7% in 2024 and 10.4% in 2025, driven by a mild reduction in margins and a slight rise in the cost of risk.
Where compression will bite hardest
Margin levels differ widely across the euro area, ranging from 0.87% in France to 3.86% in Latvia in the first quarter of 2024. The ECB identified banking systems with large shares of floating-rate loans and liquid assets as the most exposed to falling reference rates.
Net interest margin and return on equity of significant institutions, Q1 2024
| Country | Net interest margin | Return on equity |
|---|---|---|
| Euro area (SSM aggregate) | 1.62% | 9.67% |
| Greece | 3.37% | 13.92% |
| Portugal | 3.03% | 15.23% |
| Spain | 2.90% | 12.43% |
| Austria | 2.47% | 12.91% |
| Italy | 2.31% | 14.81% |
| Netherlands | 1.55% | 11.33% |
| Belgium | 1.42% | 5.08% |
| Germany | 1.10% | 7.37% |
| France | 0.87% | 6.19% |
Source: European Central Bank (ECB Banking Supervision), ECB publishes supervisory banking statistics on significant institutions for the first quarter of 2024 (press release, 26 June 2024), 26 June 2024; European Central Bank (ECB Banking Supervision), Supervisory Banking Statistics for significant institutions, First quarter 2024, 26 June 2024.
Systems where margins rose furthest on the back of floating-rate repricing stand to give back the most as rates fall, while low-margin systems have less to lose but also a thinner cushion. With funding costs still lagging and the policy path open, the first quarter of 2024 is likely to mark the high point of this margin cycle in the data, and the speed of the decline to depend on how far deposit costs follow policy rates down.
What to watch
- Second half of 2024: the ECB reduces its PEPP portfolio by €7.5 billion per month on average.
- End of 2024: the ECB intends to discontinue PEPP reinvestments.
- Q2 2024 to Q3 2024: the period over which banks in the April 2024 survey expected a net negative margin effect from ECB rates.
Primary sources: European Central Bank (ECB Banking Supervision), ECB publishes supervisory banking statistics on significant institutions for the first quarter of 2024 (press release, 26 June 2024), 26 June 2024; European Banking Authority, Profitability of EU banks remains resilient although the sector is confronted with materialising credit risks (press release, 20 June 2024), 20 June 2024; European Central Bank, Monetary policy decisions (press release, 6 June 2024), 6 June 2024; European Central Bank, Financial Stability Review, May 2024, 16 May 2024; European Central Bank, The euro area bank lending survey, First quarter of 2024, 9 April 2024; European Central Bank (ECB Banking Supervision), Supervisory Banking Statistics for significant institutions, First quarter 2024, 26 June 2024; European Banking Authority, EBA Risk Dashboard, Data as of Q1 2024, 20 June 2024; European Central Bank, Euro area bank interest rate statistics: April 2024 (press release, 5 June 2024), 5 June 2024; European Banking Authority, Risk Assessment Questionnaire, Spring 2024: data for Slide 2 (RAQ question 3), 20 June 2024.