Recovery zone

Europe's terrible banks look their best in years

Europe's terrible banks haven't looked this good in years. Capital levels, return on equity and lending across the banking sector rose in the six months to June, data from the European Banking Authority (EBA) shows. Europe's banking union is still a work in progress, but the evidence from the first half of this year is that it's helping.

Perspective is needed. The EBA's data, which covers more than 100 European banks and two-thirds of the region's assets, shows that bad loans as of June 30 were 5.6 per cent of total lending or a whopping euro 1 trillion. That's roughly double the healthier level at US peers and it's plausible that this overhang could be holding new lending back.

Still, this is a big improvement in a short period of time. Aggregate return on equity almost doubled to 9.1 per cent, meaning that the average European bank is almost making an economic profit: the EBA reckons the cost of equity is between nine per cent and 10 per cent. The two main measures of capital ticked up nicely: the average common equity Tier 1 ratio rose 60 basis points to 11.8 per cent as of end-June, while the mean leverage ratio stood at 4.9 per cent. Corporate and retail lending volumes were up 3.9 per cent, in line with the wider euro zone's economic upturn.

The market might still be too positive on European banks' prospects. Morgan Stanley reckons more quantitative easing by the European Central Bank would hurt future business, given lenders still make 60 per cent of their revenue from the difference between the interest rates they pay and those they charge. It believes this so-called net interest income will grow just 1.1 per cent next year, versus average analyst consensus for it to rise 3.6 per cent.

There's also significant divergence. Return on equity was 15.8 per cent at Norwegian banks and 14.4 per cent at Swedish counterparts. By contrast, German lenders were laggards, with just a 6.2 per cent average. Non-performing loans paint a similar picture, with the Swedish average around one per cent versus more than 40 per cent in Cyprus. European financial institutions are far from equal, but as a group they seem to have finally turned the corner.