Profitability across European banks dipped to 7% on average and prospects for an improvement remain bleak amid low interest rates and the threat of higher impairments, the region's banking watchdog said.
The European Banking Authority said return on equity for 131 banks across 27 countries averaged 7% in the 12 months to the end of June, down from 7.2% a year earlier.
"There are hardly any clear catalysts for an improvement in bank profitability that appear on the horizon. It tends to be rather the other way round," the EBA said on Friday.
"Even though low rates might be supportive when it is about the costs of market-based funding and new lending volumes, they still pose pressure on banks' NIMs [net interest margins]," it said in its annual report on risks in the industry.
RoE has improved from an average of 3.5% in December 2014, but the data show most banks are still struggling to get returns above their cost of equity.
The EBA said less than 60% of banks said their RoE was above their cost of equity. The truth is likely to be far lower than that - bankers estimate cost of equity is broadly 8%-10%.
The watchdog said the "unattractive profitability prospects" are reflected by market valuations: only 28% of listed EU banks trade at a price-to-book value above 1, compared with 81% of US banks.
It is a worry for regulators, as well as banks. Low profitability limits capacity to generate capital and to fund loan growth, or pay dividends, or absorb loan losses if there is a downturn in economic conditions.
The EBA said banks point to potential cost cuts as the main area to improve profitability. "However, over the past few years banks have struggled to adapt the evolution of their operating expenses to the fall in net operating income," it said.
The EBA released the report alongside a detailed "transparency exercise" of bank data.
Operating expenses grew by 1.5% in the year to the end of June, higher than a 1.1% rise in net operating income in the period.
The increase in expenses was driven mainly by a 2.5% rise in staff costs, which account for about 54% of expenses.
CAPITAL UP, NPLs DOWN
The overall soundness of the EU banking system improved in the past year, however, and capital ratios and asset quality continued to nudge higher, the EBA report showed.
The EBA's sample of 131 banks included 17 in Germany, 12 in Spain, 11 in Italy, 11 in France and six each in the UK, the Netherlands, Sweden and Luxembourg.
The common equity Tier 1 ratio at the end of June averaged 14.4% across the banks on a fully loaded basis, up from 14.3% a year earlier. The EBA said banks with the lowest capital ratios had improved by the largest amount.
The ratio of non-performing loans to assets decreased to 3% from 3.6% a year earlier, continuing a long-term trend.
Asset volumes across Europe increased by 3% in the past year, which the EBA said confirmed the end of the deleveraging trend.
But it warned that could pose challenges. Banks have significantly increased their lending portfolios in riskier areas, such as loans to consumers, commercial real estate and small and medium-sized firms. It said banks indicated they plan to keep increasing these exposures.
"Banks’ focus on rather riskier segments shows their search for yield in an environment of low interest rates and shrinking margins," the EBA said.