Higher interest rates do not mean the rapid improvement of European banks

An increase in interest rates is not a panacea for European banks as some might think, and the sector needs patience. European bank shares have done well so far this year, up about 6% even as markets slumped across the board. There are expectations for rate hikes, albeit lagging in the Eurozone compared to the UK and the US.

As interest rates rise, banks tend to increase their income. But this is no longer so simple. Extraordinary financial support measures put in place in response to the pandemic must be withdrawn, until bank returns return to normal.

In the midst of the health crisis, European banking regulators put in place rules to ensure the proper functioning of the “financial pipeline”, in order to ensure that banks continue to lend and maintain healthy capital reserves, with interbank exchange rate adjustments, lowering capital requirements and also the use of veto power (veto) on dividends and bonuses.

The measures helped to avoid a crisis in the sector. Now is the time to gradually reduce subsidies. The ban on shareholder returns has already been lifted, which should generate a flurry of buybacks and dividends this year.

However, rolling back other policies is likely to take more time, and it is difficult to predict how the process will affect banks’ profits. From now on, higher interest rates should mean greater profits for the banks. In the short term, they may have to make do with share buybacks and dividends.