ECB: European Banks Demonstrate Strong Capital, Liquidity, and Profitability

European lending institutions were asked to make further progress in “digital transformation and building reliable operational resilience systems,” as well as to “effectively address shortcomings in climate and environmental risk management.”

On Tuesday, December 19, the European Central Bank (ECB) published its results of its Supervisory Review and Evaluation Process (SREP) for 2023, as well as its supervisory priorities for the three-year period 2024 to 2026.

According to the ECB press release, “the eurozone banking sector continued to demonstrate strength and good resilience in 2023.” European lending institutions on average maintain “solid capital and liquidity positions, well above regulatory requirements.” Profitability has returned to levels not seen in more than a decade, strengthening the ability to withstand external shocks, according to the results of the 2023 pan-European stress test.

However, “the weak macroeconomic outlook” and tightening financing conditions remain a source of risk for European banks. Rapidly rising interest rates have helped boost overall bank profitability, but this effect will diminish as higher interest rates are passed on to depositors. At the same time, higher rates have contributed to credit, valuation, and liquidity risks. The March 2023 market turmoil highlighted just how important it is for the banking sector to manage interest rate risk effectively.

“In this context,” the European regulator emphasized, “the average SREP score remained broadly stable at 2.6 (in a range of 1 to 4), with 70% of banks scoring the same as in 2022, 14% scoring worse and 15% scoring better.”

In 2023, the ECB stepped up efforts to ensure banks took overdue action to address outstanding findings and measures imposed on them. It issued qualitative measures, a key component of its supervisory toolkit, primarily to address deficiencies related to internal governance, credit risk management and capital planning. “Banks,” the ECB noted, “need to keep paying particular attention to internal governance.” This is because “three out of four have received measures to address deficiencies in that area.” There was a substantial rise in measures issued to address liquidity risk and interest rate risk in the banking book, triggered by the changing macro-financial landscape.

Regarding the new banking supervision priorities set by the ECB for 2024-2026, it has been decided that in order to improve the resilience of banks to immediate macro-financial and geopolitical shocks, the Regulator will ask banks to address shortcomings in their asset and liability frameworks and credit and counterparty credit risk management. “Banks,” the statement said, “must also accelerate the effective remediation of shortcomings in internal governance and the management of climate-related and environmental risks.” Finally, lenders were asked to make further progress in “digital transformation and in building robust operational resilience frameworks.”