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R I S K A S S E S S M E N T O F T H E E U R O P E A N B A N K I N G S Y S T E M

7

about trading market liquidity. Central bank

based funding as well as asset encumbrance

levels remain high. It shows that trust across

banks in the single market is not yet fully re-

stored, and that funding markets have not

yet returned to pre‑crisis conditions. Finally,

banks remain vulnerable to any snap back in

risk appetite that could make it more expen-

sive or difficult to access term funding and /

or raise Additional Tier 1 (AT1) or Tier 2 in-

struments.

EU banks still face important challenges to

profitability.

The return on equity (RoE) as

of December 2014 was 3.6 %, the highest

year‑end value since 2011. The main drivers

for this modest increase are the growth of the

net interest income and a decline of impair-

ments of financial instruments. The positive

trend of net interest income during 2014 is

partially explained by a growth of total loans

and debt instruments as well as a decrease

in funding costs. On the other hand, asset

quality remains a drag and conduct‑related

charges and litigation costs pose a signifi-

cant toll on banks’ profitability. RoE remains

thus subdued and insufficient to cover the

cost of equity (CoE) for many banks, which

may encourage disproportionate risk taking

or cost cutting in an effort to increase prof-

itability. Moreover, there are doubts on the

sustainability and viability of certain banks’

business models while there is little clarity

on what strategies banks have in place to re-

turn to adequate levels of profitability as they

move away from official funding. Plans of EU

banks to return to traditional lending busi-

ness might determine increasing competition

and, in turn, further pressure on margins.

Further changes to business models might

arise.

The regulatory reforms already im-

plemented and the essential restructuring

process of the EU banking sector initiated

after the crisis have triggered important

changes to banks’ business models as well

as a consolidation in the sector. Still pro-

found changes are likely to occur, mainly

linked to resolvability of banks envisaged in

the context of the bank recovery and resolu-

tion directive (BRRD), and to the structural

separation of banks’ business proposed in

the Liikanen report. Banks’ plans would re-

flect the ‘back‑to‑basics’ trend, refocusing

on core activities and markets.

Segmentation within the single market per‑

sists both on the asset and on the liability

side.

The levels of impairments still show

a wide range between the countries, partially

influenced by local laws in some jurisdictions

that slow the recovery process for non‑per-

forming loans. Consolidated foreign claims

for EU banks decreased during 2014, giving

evidence of subdued levels of cross‑border

lending. Further efforts for ensuring conver-

gence of approaches and methodologies for

the supervision of banks are a precondition

for restoring confidence in the single market.