European banks are expected to see profit declines in 2025 as falling interest rates pressure net interest income, although strong loan growth and resilient fee income should help sustain profitability, said Morningstar DBRS, a global credit rating agency, in a commentary on 13 November 2024. Despite this, the agency anticipates that EU banks will maintain solid performance throughout 2025.

In the report, Morningstar DBRS noted that European banks are entering 2025 with robust capital buffers. The agency pointed to strong internal capital generation in 2024, which offset increased capital returns to shareholders. However, the report highlighted a potential downside scenario in the form of heightened global trade tensions, which could impact European exports and, by extension, asset quality and economic growth assumptions.

Asset quality

While Morningstar DBRS anticipates only a slight deterioration in asset quality in 2025, certain corporate sectors may face ongoing challenges. The report indicated that weaknesses in sectors including energy-intensive industries, automobile and real estate would be largely offset by a better overall economic outlook and lower interest rates. Additionally, households across Europe are benefiting from rising wages and a reduction in borrowing costs, further supporting the stability of asset quality.

In the event of increased trade tensions, however, EU banks could face a more significant deterioration in asset quality, cautioned Morningstar DBRS. The report stressed that banks were well capitalised to absorb any potential higher credit losses in the near term, a view echoed by Sonja Förster, senior vice president of global financial institutions at Morningstar DBRS. Förster warned in the report that any adverse economic developments, particularly those stemming from global trade issues, could alter the current outlook for the sector.

Earnings outlook

The financial outlook for 2025 points to a more challenging year for EU banks. Morningstar DBRS expects a decline in earnings driven primarily by the fall in net interest income, which constitutes more than 70% of European banks’ core revenues. The drop in interest rates, which has already started to pressure margins, is expected to continue in 2025, further squeezing profitability. However, the report also anticipates that credit costs will remain largely unchanged compared to 2024, reflecting the moderate improvement in economic performance.

Banks that benefitted most from the previous interest rate increases, particularly in countries like Portugal, Greece and Ireland, are expected to experience the largest declines in net interest margins in 2025. In contrast, banks in countries such as Germany, the UK and the Netherlands--where deposit betas have been higher--will likely see more moderate net interest margin declines.

The report also highlighted that banks in France, where regulatory requirements have resulted in the highest deposit betas in Europe, are expected to experience some improvement in margins, albeit from a low base. Morningstar DBRS did not analyse similar data for Luxembourg, a representative told Paperjam.

Loan growth

While the decline in net interest income will weigh on overall bank performance in 2025, Morningstar DBRS expects loan growth to partly offset these pressures. The report indicated that both household and corporate loan growth had started to recover in the Eurozone by the first half of 2024 and the trend is expected to continue into 2025. As interest rates fall from their peak levels and wages rise, mortgage activity is gradually picking up, particularly in Southern European countries.

Additionally, loans disbursed through Europe’s national recovery and resilience plan are helping to boost loan growth in Greece and other Southern European nations. The report noted that these loans are being channelled through banks, contributing to higher loan volumes in these regions. Although the impact of these funds is expected to be more indirect in other countries, the overall trend is one of gradual recovery in loan growth.

Fee income

European banks reported an 8% year-on-year increase in fees and commissions in the first half of 2024, supported by strong performance in capital markets. Morningstar DBRS expects fee income to remain relatively resilient in 2025, driven by a stronger economy and continued demand for services in asset management, brokerage, insurance and investment banking.

The firm highlighted that while capital market performance is inherently unpredictable, lower interest rates should bolster debt underwriting and fixed income sales. Furthermore, as the economy strengthens, banks are likely to see higher transactional fees, which should provide further support to their bottom lines.

Cost pressures and wage inflation

Operating costs for European banks rose by 7% year-on-year in the first half of 2024, driven primarily by wage inflation and ongoing investments in various sectors, including technology and cyber security. Morningstar DBRS expects operating costs to continue rising in 2025, albeit at a slower pace. Some banks have implemented rigorous cost-cutting measures, which have helped offset the impact of wage inflation. Nonetheless, banks will still need to invest in technology and security infrastructure, as these areas will remain a focus of regulatory scrutiny in the coming years.