Higher interest rates do not mean rapid improvement for European banks

The increase in interest rates is not the panacea for European banks as some might think, and patience is needed for the sector. European bank stocks have done well so far this year, up around 6% even as markets across the board slump.

There are expectations for interest rate hikes, albeit lagging in the eurozone compared to the United Kingdom and the United States.

With high interest rates, banks tend to increase their income. But this is no longer so simple. The extraordinary financial support measures put in place in response to the pandemic need to be withdrawn, so that banking returns normalize.

In the midst of the health crisis, European banking regulators have established rules to ensure the smooth functioning of the “financial pipeline”, in order to ensure that banks continue to lend and maintain healthy capital buffers, with interbank rate adjustments, cutting capital requirements and also veto dividends and bonuses.

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

Rolling back other policies, however, is likely to take more time, and it is difficult to predict how the process will affect bank profits. Going forward, higher interest rates should mean bigger profits for banks. In the short term, they may have to make do with share buybacks and dividend distributions.