How European banks defied expectations to show resilience and growth

European banks' Q2 2024 results show resilience with less revenue pressure than expected, raising full-year guidance and valuations by 15%.

In brief

• European banks outperformed expectations with strong resilience, leading to upgraded full-year guidance and a 15% increase in valuations.
  
• Key performance drivers included a 6% rise in fee income robust net interest income, and positive operating leverage with controlled cost growth.
  
• Strategic focus on AI, digital transformation, and sustainable finance positions banks for future profitability, despite current discounts to book value.
  

The anticipated pressures on European bank revenues, based on 17 large European banks that have reported so far, were less than feared this past quarter. Results show an impressive resilience, prompting more than half of banking leaders to upgrade their full-year guidance. Investors have taken note, lifting valuations by around 15% year to date. The average price-to-book ratio for major European banks, as of 1 August 2024, now sits at 0.75x vs. 0.67x at the start of the year.

Here are five key takeaways from the earnings that have been reported so far:

1. Fee income rebounds: We've seen a 6% surge in revenue growth compared to the same period last year, driven by a significant uptick in investment banking activities. Global deal-making hit a two-year high as confidence grew that policy rates have reached their peak. Additionally, wealth management has seen a resurgence, with clients actively repositioning their portfolios in anticipation of rate normalization, and robust equity markets have bolstered assets under management.
   
   
2. Net interest income holds strong: Investors had expected at the start of the year that net interest income growth would decelerate. It was assumed that the dynamics seen in the early stages of the rate hike cycle, where loan repricing outpaced deposit repricing, would go into reverse. That now appears to have been rather pessimistic. Deposit pricing pressures have eased more than anticipated across the board, including in markets such as the UK and Germany, which faced significant challenges in 2023. This positive development has led over half of the sector's banks to raise their full-year net interest income forecasts, with many others expressing more confidence in meeting their targets.
   
   
3. Positive operating leverage: The sector's revenue growth has outstripped a 4% increase in costs, resulting in positive operating jaws. Banks are channeling their investments into digitalization and cloud-based tech modernization, while fortifying defenses against financial crime.
   
   
4. Credit quality continues to surprise: Loan impairments stayed low, and banks reported no new signs of stress across their exposures. Even within office commercial real estate, which remains in slump, banks are proactively managing their exposures, working with borrowers to restructure loans to prevent defaults and adhering to stricter underwriting standards.
   
   
5. AI at the heart of strategic transformation: Despite the uptick in valuations, European banks are still trading at a 25% discount to book value, which reflects lingering investor concerns about the sustainability of recent profit gains. It was therefore encouraging to hear banks discuss how they are adopting artificial intelligence (AI) to enhance efficiency, drive revenue growth and refine risk management. While I’ve sensed growing interest in banks’ AI initiatives during the last few earnings calls, it’s worth noting that only a quarter of European banks discussed AI in their calls this reporting season – compared to “three-quarters” of large US banks.

Other initiatives include the launch of the world's first gender bond, which aims to improve housing access for low-income women and enhance living standards for gender minorities. Improving social outcomes is an area of increasing focus, as highlighted recently by Chris Woolard in his latest blog - Quarterly update on global financial services regulatory developments. EY data collected for the top 100 global banks suggests that European banks are outpacing their global peers in sustainable finance; they extended $308 billion in ESG-related loans in 2023, compared to $203 billion by North American banks and $155 billion by those in the Asia Pacific (APAC) region.