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High interest rates pushing profitability of Eurozone banks to new highs

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The Eurozone continues to provide more positive signs and is reaffirming its ability to hold together in the face of a number of negative factors, most notably the extremely tight credit environment.

This week the European Central Bank shared its Financial Stability Review report, which provides in-depth insight into how higher interest rates, monetary tightening and the surrounding risks will impact various aspects of the region’s economy.

The report reaffirmed the ability of the Eurozone banking system to hold together and avoid collapses as occurred in the US and Switzerland. It also pointed out that high interest rates have pushed banks’ profitability to record levels during the current year, with net interest income (NII) mainly rising.

Eurozone economy still facing some risks

The report said that the strength of the labour market, despite the difficult conditions, has helped the banking system avoid a high percentage of non-performing loans (NPL), which in turn is still very low, and government support for households and employers has also contributed greatly to this.

A few days ago, Christine Lagarde also praised the strength of the labour market, which supported the strength of the banking system, despite high inflation.

In contrast, the report, from its beginning, did not hide the concerns of monetary policy officials about the risks surrounding the region’s economy. The escalating conflict in the Middle East and upside risks to inflation – supported by the possibility of another sharp rise in energy prices – remain a major concern that could threaten sustainable growth and the stability of the banking system.

Insurance companies are suffering

Although the profitability of banks also increased as a result of the increase in net interest income, the tight monetary policy and high interest rates, which were accompanied by a negative outlook on the future of growth and the possibility of current rates remaining high for a longer period than expected, reduced the demand for credit and caused damage to the investor portfolios. This was especially the case in the non-banking sector, including insurance companies.

Insurance companies have suffered from a decline in the valuation of their investment portfolios (especially those concentrated in fixed income instruments) due to the record high bond yields and the significantly high risk of default.


“These negative sentiments, in addition to the difficult credit conditions, also continue to threaten the real estate market, which is suffering from falling prices in light of declining demand and rising costs,” said Mohamad K. Ibrahim, the Group CEO at CFD broker XS.com in Dubai.

The ECB report also stressed that the return of high inflation in the Eurozone may threaten the ability of borrowers to commit to repayment, which may also threaten the integrity of the banking system again, especially in countries that have a high percentage of loans with variable interest rates.

“It seems that the Eurozone economy…provided more reassuring signs about its health and strengthened the positive sentiment in the markets, which continued to price this in a continuous manner this year, with optimism that the monetary tightening is nearing an end and a soft landing in inflation will be achieved,” Ibrahim explained.

These positive expectations have already been reinforced with a series of economic data during the months of November and October, both from the gradually improving purchasing managers’ (PMI) figures and the trend to eliminate the continuous contraction in manufacturing and services activities. In addition we have seen the return of confidence by institutional investors in the region’s economy and its ability to recover with the latest two ZEW Economic Sentiment reports for Germany and the Eurozone.

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This article does not constitute investment advice. Do your own research or consult a professional advisor.

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