Flattening RoE YoY amid fading support from net interest income

The RoE of EU/EEA banks remained nearly stable from June 2023 to June 2024, recording only a 10 bps decrease to 10.9%, and very close to the highest levels reported by the sector. While the increase in NII was previously a key determinant for the rise of banks’ RoE, in recent quarters its additional contribution dropped to just 10bps (YoY change). The most substantial positive factor, accounting for 80bps, was the significant reduction in contributions to DGS and resolution funds, as these funds should have reached their target levels by the beginning of 2024. Other expenses, including taxes, had the most negative impact, reducing RoE YoY by 80bps. This is likely attributable, at least in part, to the heightened taxation on banks – also referred as ‘windfall taxes' – implemented in certain Member States in response to the substantial profits recorded in the past year due to higher interest rate environment. Rising NFCI as well as NTI and declining other administrative expenses made slightly positive contributions to the YoY change of the RoE. Conversely, YoY changes in other operating income, provisions and impairments had negative impacts (Figure 50).

Source: EBA supervisory reporting data

Despite  historically high level of profitability, EU/EEA banks’ RoE on average currently tends to be below their CoE. Nearly 70% of banks report CoE higher than 10%^[1] (Figure 51). The elevated CoE is not solely the result of high interest rates, but likely also reflects broader macroeconomic and geopolitical risks, along with specific sector-related risks^[2]. It is similarly reflected in banks’ valuations, with on average price to book (PtB) multiples below one (Figure 65).

Source: EBA Risk Assessment Questionnaire

NII is the key component in EU/EEA banks’ RoE, reaching around 60% of EU/EEA banks’ total net operating income^[3]. There is, however, notable dispersion across Member States regarding their RoE levels, largely due to differences in NII. The trend in NII is influenced by several factors, including interest rate levels in the jurisdictions to which banks are exposed to and aspects like asset and liability composition and their repricing periods. Banks, for example, with exposures to CEE countries benefitted from the higher interest rates in these currencies. Other countries, such as the Baltic countries or Cyprus, presumably benefited from the faster and / or stronger repricing of the asset side vis-à-vis the slower and / or more muted repricing of their liability side. The contribution of interest income from central bank deposits might also have positively contributed to some banks’ RoE last year, despite the substantial decline in central banks’ deposits  (see Chapters 2.1 and 3.3). However, respective banks appear to experience greater pressure on their profitability due to central bank interest rate cuts and generally decreasing interest rates (see Figure 2 on currency interest rate levels). Banks in other countries, in contrast, still reported an increase in RoE, as they were presumably not yet hit to the same extent by the decline in interest rates. Nevertheless, NII developments depend on many other parameters, such as the asset and liability mix, prevalence of business models, and ability to maintain deposit betas low. The significant impact of NII on RoE is evident through a revenue composition analysis, which shows that countries with elevated profitability tend to have a higher ratio of NII to equity (Figure 52).

Source: EBA supervisory reporting data

Source: EBA supervisory reporting data

In the past, banks have demonstrated their ability to increase fee income when necessary

Fee income, the second most important revenue contributor reaching around 30% of total net operating income, has risen by around 8% YoY. Asset management and related products remained the key component (share of ca. 34% in total fee income), followed by payment services (share of ca. 28% in total fee income), which is similar to last year^[4]. When calculated as share of related underlying volume, asset management fees had for instance risen from 45bps in 2021 to 49bps in 2022 and declined in 2023 and 2024 to now 44 bps. Current account related fees grew from 13 bps in 2021 to 15 bps in 2023, before remaining flat this year. The levels of these fee components widely differ among countries. However, looking on the development of these fee components, many countries show similar trends with rising fee levels in recent years (Figure 53).

Source: EBA supervisory reporting data

(*) The fee income component is Q2 annualised data for each of the years

In sight of the policy rate cuts across the continent, the pressure on NII is expected to intensify, incentivising banks to shift their attention to other sources of income to support their profitability levels. This is similarly reflected in the outlook through the RAQ results as a substantially smaller number of banks, compared to the previous two surveys, rely on NII to boost their profitability. At the same time, according to RAQ, banks increasingly prioritise to enhance their net fees and commission income while reducing their cost functions. This shift demonstrates a diversification of banks’ activities in the expectation of their RoE growth and shows that banks are dealing with the possible impact of lower rates. However, fee income faces pressure not only from competition within the banking sector but also from BigTech and Fintech firms. Depending on potential synergies with these firms, this an area that banks could benefit.  It may also come under pressure due to other developments, such as the potential introduction of central bank digital currencies (CBDC), depending on their concrete design^[5]. RAQ results further indicate that banks are not aiming to raise the deposit and current account related fees (Figure 30). Despite the shifting trends in NII dynamics, which have led 60% of banks to have a bleak outlook on profitability growth, 40% of banks still anticipate an improvement within the next 6 to 12 months (Figure 54).

Rise in costs below average inflation rate

Overall cost rose by less than 1% on an annual basis. Staff expenses remained the main component in total expenses, followed by other administrative expenses. Staff and other administrative expenses show major differences among countries, contributing to a relatively wide dispersion of overall costs and expenses. Measured in relative terms as share of equity, staff expenses tend to be lower in Nordic countries, but also several other countries fare favourably in this respect. For Nordic countries this is not least due to a presumably higher level of automatisation and digitalisation. This may also explain why other administrative costs are typically the lowest in Nordic countries (Figure 55).

Due to higher increase in revenues than in costs, EU/EEA banks’ cost-to-income ratio declined on a yearly basis from 57% to 53%. Most of the countries similarly saw a decline in the cost-to-income ratio. However, there are also several Member States that saw a rise. Notably, several of these countries have relatively high administrative costs. In other cases, the rise seems to be also driven by a decline in revenues. The average rise in costs of around 1% compares favourably with the average YoY inflation for the EU as of June 2024, which stood at around 2.6%. Assuming costs would have increased by the average EU inflation rate, banks’ RoE would be around 40bps lower and their cost-to-income ratio would be more than 1p.p. higher.

The CoR increased annually in the EU/EEA, from 45 bps to 51 bps. It stayed within the range of approximately 40 bps to 50 bps, a trend seen since June 2021, with the exception of Q1 2024, when CoR rose to 56 bps (Figure 64). According to RAQ, most banks expect these provisioning levels to remain below 50 bps. On country level there was still some major divergence, with some country averages reported notably higher than a year earlier. Banks in most of the Baltic as well and Nordic countries reported the lowest CoR (Figure 57).

(*) Data for LT skewed higher due to the sample, which include rather high-risk banks and not the biggest national lenders.

Box 7: Business model plays a prominent role in determining profitability The evolution of profitability is also subject to discrepancies between business models[6]. Cooperative and cross-border banks have experienced a decrease in their RoE since 2023 (-1.5 pp and -0.3 pp respectively). This was similar for corporate-oriented banks (-0.2pp). The latter banks additionally struggle to catch up with their peer’s RoE level, standing at 5.9% in 2024, and being in many of the past years below other banks’ profitability. This is not least due to the low level of NII of corporate banks. This comparably low NII is presumably due to pressure from deposit costs[7]. Furthermore, NFCI is significantly lower at corporate-oriented banks than other business models (Figure 58). Source: EBA supervisory reporting data Figure 58b: RoE and its key income components as share of equity, by business model, Jun-2024 Source: EBA supervisory reporting data At the same time, corporate-oriented banks report the lowest levels of costs, presumably because they are more efficient amid their wholesale business focus. However, despite being more efficient, this does not compensate for their lower revenues. The results also show that cross-border universal banks have the highest cost, driven by staff expenses. Their other administrative expenses and impairments are also comparatively high. Higher staff costs and other administrative expenses might indicate that operating a cross-border bank implies higher cost base. The higher impairments presumably reflect their wider geographical dispersion, which presumably also includes exposures in countries with elevated cost of risk. Yet, they manage to compensate this with a higher revenue base. Overall, cross-border universal banks report close to the overall average RoEs (Figure 59). Figure 59: Key components of costs and expenses as share of equity, by business model, Jun-2024 Source: EBA supervisory reporting data

A topic particularly in focus in recent years were taxes, as there were several Member States introducing new sector specific taxes, which often included the banking sector, and were often referred to as 'windfall taxes’^[8]. Data indicates that banks’ tax expenses rose in many countries since 2022. Taking the simple average of the country specific results, taxes and similar payments rose by around 2 p.p. between 2022 and 2024 (tax and similar payments as share of profits before these payments^[9]).

Banks continue to invest in digitalisation and automatisation to limit long-term cost growth

Looking forward, RAQ results show that banks keep on targeting automatisation and digitalisation to reduce their operating expenses. This has a detrimental effect in the short-term profitability capacity as any investments towards automatisation and digitalisation add to immediate expenses, as do other ICT related expenses. The reduction of overhead and staff costs remains banks’ second most important measure to reduce their operating expenses, but with less relevance compared to previous years (56% agreement now vs. 80% agreement in 2021). Amid the relatively high staff expenses at cross-border universal banks, one might have expected that a particularly high share of them might aim for such cost reduction measures (see Box 7). However, the share of cross-border universal banks aiming for overhead and staff cost reductions is only around 10p.p. above the share of the full sample of banks in the RAQ results. This may indicate limited cost saving potential in this area for those banks (Figure 60).

During the last years, there has been a low number of bank related M&A transactions in the EU/EEA. Among these transactions domestic ones have the biggest share, followed by M&A within the EEA. Transactions with parties outside the EEA are even more rare. This confirms that the higher level of attractiveness of EEA internal M&As, than for transactions outside the EEA. It is an aspect, which is similarly reflected in the latest RAQ results on banks’ plans for M&A transactions. This might also be affected by the cost related issue described above, but also due to regulatory or similar hurdles and challenges^[10]. (Figure 61).

(*) Completed transactions – including whole company, minority, branches and assets acquisitions and / or mergers – involving a bank in the EEA as geography. Private equity deals are included. The volume related information / data is only available for some of the transactions, for which reason the number of deals might be considered as more relevant.

Box 8: EU vs US banks’ differences in profitability and potential links to their valuation Over the past 6 years, US banks have generally been more profitable than those in the EU. Only in 2023 EU/EEA banks showed higher profitability, amid a decline of US banks’ RoE. The latter seems to be driven by a temporary contraction of fee and other income as well as a spike in expenses, which is mainly due to HNWI contributions amid the Silicon Valley Bank induced events last year[11]. However, US banks’ profitability slightly surpassed EU/EEA banks’ again in 2024. Likewise, US banks have consistently reported higher return on assets (RoA). This box explores how various elements of banks' RoE might account for the consistent advantage of US banks. One parameter in the analysis is equity, as a starting point, as the RoE’s denominator. Using capital as a proxy for comparing this parameter, data shows that EU/EEA banks’ leverage ratio has been constantly below that of their US peers, which implies that US banks’ have higher capital levels relative to their assets[12]. This suggests that US banks need higher earnings to achieve comparable or superior RoE compared to EU/EEA banks. (Figure 62). Figure 62a: EU vs. US banks’ RoE* Source: Federal Reserve Bank of New York and EBA supervisory reporting data, EBA calculations Figure 62b: EU vs. US banks’ leverage ratio Source: Federal Reserve Bank of New York and EBA supervisory reporting data, EBA calculations (*) For the US data the Federal Reserve Bank of New York’s “Quarterly Trends for Consolidated U.S. Banking Organizations” as of Q2 2024 is used. Looking at the two of the most important income components of the numerator of the RoE, both NII as well as fee and other income, measured as a share of equity, tend to be higher for US banks than EU banks. US banks' NIM is consistently higher, influenced by the pricing of assets and liabilities, which depends for instance on their product mix and pricing convention (variable or fixed rate loans, high yielding vs low yielding business, etc.), deposit betas, client structure, competition in specific segments and sectors, but also the interest rate levels as set by the central banks (Figure 63). Figure 63a: EU vs. US banks’ NII as share of equity Source: Federal Reserve Bank of New York and EBA supervisory reporting data, EBA calculations Source: Federal Reserve Bank of New York and EBA supervisory reporting data, EBA calculations The cost efficiency ratios paint a more mixed picture though. The cost-to-income ratio  of EU/EEA banks declined notably in recent years, in contrast with the US banking sector, where it has been on a slightly upward trend. As a result, US banks’ CIR has been above the EU one since 2021. At the same time the picture of cost of risk was rather mixed and significantly more volatile, especially for US banks[13]. Since the pandemic, cost of risk in US banks was above their EU peers, while over the last 6 years the average cost of risk for EU banks was marginally higher than US banks (54 bps vs 53 bps respectively) (Figure 64). Source: Federal Reserve Bank of New York and EBA supervisory reporting data, EBA calculations Source: Federal Reserve Bank of New York and EBA supervisory reporting data, EBA calculations (*) For the US banks’ cost of risk the annualised loan loss provisions as percentage of total loans from the data the Federal Reserve Bank of New York’s US banking sector data are used. The profitability comparison of the two banking sectors demonstrates that US banks despite their higher cost base, supported by higher NII, NIM and also fee and other income, manage to consistently fare better than EU/EEA banks. There are presumably many reasons for US banks’ higher revenues, including diversification of income, asset mix, including the use of securitisations to move certain exposures from the balance sheets, asset quality (legacy loans), but also the macroeconomic environment, including interest rates and economic growth. The market structure might similarly contribute to the differences in revenues and overall profitability. Whereas US banks benefit from a fully integrated common market at home, their EU peers do not benefit from a fully integrated banking and capital markets union, and are challenged with market fragmentation. Further aspects include for instance the political environment, prudential, liquidity and other regulatory aspects as well as technological and innovation headroom due to investments made in the previous decade by US banks. Even though valuations are driven by many parameters and are particularly driven by the expectations related to an investment, one might still argue that different profitability levels are at least partially also reflected in respective banks’ valuations. EU banks’ valuations have been below those of their peers for years. PtB multiples provide a measure for banks’ valuations[14]. EU banks’ PtB multiple stands at around 0.8 whereas for US banks’ it reached around 1.3 in September 2024. The trend in bank valuations over time shows that EU banks had some periods in which they could narrow the gap to their US peers. This was for instance the case at the beginning of the pandemic in 2020, when US banks’ RoE fell to nearly similar levels as EU banks’ RoE. US banks’ valuations declined significantly more than for EU banks at that time. In 2023 EU banks’ profitability outperformed that of their US peers not least due to different perceptions of the rate expectations, but also in the aftermath of the SVB induced crisis events. That time, US banks’ valuations declined amid their contraction in profitability, and the gap between EU and US banks’ valuations narrowed again (Figure 65). Source: Bloomberg (*) The Bloomberg query INDX_PX_BOOK was used for this analysis. Additional,  and maybe even more relevant, parameters defining banks’ valuations, include expectations regarding the general economic and monetary policy and interest rate environment, and how this affects banks’ profitability going forward. Investors’ investment strategies, such as  focusing on dividend investing or  value investing (i.e. investing in stocks that seem to offer an increase in their value) can  also affect valuations of certain sectors. Another factor, could for instance be windfall taxes for banks that might have affected the valuations of certain banks in recent quarters.

Abbreviations and acronyms