Luxembourg banks set themselves apart with the highest CET1 ratio in the EU, yet their profitability remains a concern due to low return on equity figures. Archive photo: Guy Wolff / Maison Moderne

Luxembourg banks set themselves apart with the highest CET1 ratio in the EU, yet their profitability remains a concern due to low return on equity figures. Archive photo: Guy Wolff / Maison Moderne

Despite achieving the highest CET1 ratio of 24.73% in the European Union, Luxembourg banks struggle with a low return on equity of 1.53%, indicating challenges in profit generation.

Luxembourg banks have achieved a notable distinction in the European Union by maintaining the highest Common Equity Tier 1 (CET1) ratio among member states, according to the latest data from the European Central Bank. CET1, a key measure of a bank’s financial strength, represents the core capital a bank holds against its risk-weighted assets. As of Q1 2024, Luxembourg’s CET1 ratio stands at an impressive 24.73%, significantly higher than the EU average of 16.07% and well above other EU countries, with the next highest ratio being Slovakia, at 21.73%. The data cover 385 banking groups and 2,299 stand-alone banks and credit institutions operating in the EU, accounting for nearly 100% of the EU banking sector’s balance sheet.

Despite this strong CET1 ratio, Luxembourg banks are showing a relatively low return on equity (ROE) compared to their EU peers. ROE, which measures a bank’s profitability as net income divided by shareholder equity, for Luxembourg banks stands at 1.53% in Q1 2024. This is markedly below the EU average of 2.49% and lower than many other EU countries, with Romania leading at 6.15% and Cyprus at 5.25%. This disparity suggests that while Luxembourg banks are well-capitalised, they are struggling to translate their capital strength into high profitability.

Several factors could contribute to Luxembourg banks’ low ROE. One possibility is that high CET1 ratios, while indicative of financial stability, might also reflect conservative lending practices. Banks maintaining high capital buffers may be less aggressive in their lending and investment strategies, which can lead to lower returns on equity. Additionally, the banking sector in Luxembourg faces significant competition and on interest rates, which can compress profit margins and affect overall profitability.

The implications of this scenario are multifaceted. On one hand, the high CET1 ratio highlights the stability and credibility of Luxembourg banks, reassuring investors and regulators of their financial soundness. On the other hand, the low ROE raises concerns about how efficiently these banks are using their capital and their ability to generate strong returns for shareholders. Given the slow-changing economic conditions, Luxembourg banks may soon focus on optimising asset allocation, improving operational efficiency or exploring new revenue streams.

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