The Interest Rate Outlook
Despite their shortcomings, European banks do not seem on the verge of collapse and few commentators, analysts or policymakers think that there will be any systemic wobbles in 2018. We do not necessarily disagree; with ECB interest rates still zero to negative and a raft of generous credit facilities open to banks on softish terms there is little doubt that monetary policy has helped and will continue to help Europe’s banks. We would venture to say that supporting the banking system has been the main objective of ECB monetary policy for a decade now. Keeping rates at around zero not only ensures that mark-to-market profits are maximised, but also enables banks whose depositors might have lost confidence and withdrawn funds to fill the gap by borrowing from central banks at no cost.
The opposite view is that banks are struggling to make money in this low interest rate environment and that profits will rise when rates increase. There are three difficulties with this counter. Firstly, the market for high quality lending business remains very competitive, not least because low rates have helped many banks stay in business that might otherwise have folded. Secondly a raft of fintech businesses have emerged seeking to pick off this ‘low hanging fruit’. Fintech businesses of course have low overheads. Many are targeting the SME market. Larger corporations with internal treasury functions have always been able to borrow at skinny margins. In the retail market the European Union’s new Payment Services Directive will make it easier for third parties, with the customer’s permission, to access secure information and initiate customer payments. This is expected to put pressure on large banks’ pricing power, pushing them closer to market average pricing.
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