1. Is deposit flight a real threat to the European banking sector?
That has been the key theme in Q1. After the recent events, investors got worried about deposit flight and whether the assumption on deposit outflows are accurately modelled or not. Of course, the fallen banks were quite singular banking animals from a deposit standpoint, but it is worth looking into their deposit outflow stories to assess the read across for European banks.
Banks deposits are generally classified in four main categories: stable retail deposits, less stable retail deposits, operational corporate banking accounts and other corporate deposits accounts. For each deposit type, the Liquidity Coverage Ratio assumes a maximum outflow in stress cases. During the recent stress episodes, while less stable retail deposit outflow has massively surpassed the LCR assumptions (which is are of 12% in 30 days), outflow have remained in line for the other categories. Hence, European regulators will probably reconsider less stable retail deposit outflows assumption, but the others seem valid. Assuming the less stable retail deposit outflows would be modelled at 100% in 30 days, this would still leave European banks with a buffer.
At a certain moment during the quarter, the FT published suspicion to another level with an article titled “Money pulled from eurozone banks at a record rate”. This probably attracted loads of readers, but we couldn’t find anything scary in the related February ECB data. Out of EUR 54bn of deposits outflows, EUR 32bn went to other financial institutions. Households sight deposits went down EUR 46bn, but term deposit went up EUR 35bn. All in all, this is a EUR 12bn monthly decline in the context of a EUR 14.3trn deposit base.
Hence, deposit flight, although a justified concern within the current context, is in no way a current major weakness for European banks.
2. Will Net Interest Margins will fade away?
Fears on deposits outflows led to the assumption that NII would be at risk. Indeed, interest margin on deposit are expected to be one of the key components of European banks 2023 profits. So, this is obviously a serious challenge to the sector profitability. However, Eurozone customer spread history looked quite stable before negative rates were introduced.
The share of transaction accounts is currently high by historical standards at c. 60% in the Euro area. It is expected that customers will gradually shift to savings and term accounts as well as other fixed income products to optimise their finances. Assuming the deposit mix reverts back to its pre-2014 average (household transaction accounts at 35%), deposit spreads would still remain in the 75 bps to 150 bps band in a scenario where rates remain above 2%.
Although we are at the very beginning of the Q1 reporting for European banks, these assumptions align with what some banks have been guiding for 2024-2026.
You can find more details in the article below.
Whenever there is a bank in trouble somewhere in the world, investors tend to get nervous. In 2023, in a couple of months, three American regional banks have been put in resolution and a large systemic bank in Europe has been forced into a merger.
The US Regional banks for which these events revealed regulatory weaknesses remain under scrutiny for good reasons. But unfortunately, European banks which are about to publish a glorious Q1 got punished. Forget the February enthusiasm, European banks are now left with questions, not to say suspicion.
Let’s revisit the European Banking sector key themes to the investment thesis that emerged or been challenged recently.