Report: European banks to struggle, may need to cut costs

FRANKFURT, Germany – European banks are likely to struggle to make profits in months ahead and may need to cut costs, merge or change their business strategies to return to solid health, the European Central Bank said Tuesday.

The banks' woes present a hurdle for the economy of the 19-country eurozone, where lenders are the source of most financing for business, unlike the United States, where companies more often issue debt on capital markets.

In its review of financial stability in the currency union, the ECB said the region's banking system had weathered volatility in markets at the start of the year, and remained stable. However, it said that "most risks have increased" since the last such review in November, 2015.

It said "euro area banks continue to be confronted with an outlook of low profitability," weighed down by low interest rates, a tepid recovery in the euro countries, and by large numbers of bad loans in some countries.

The ECB, which is responsible for overseeing banks as well as interest-rate policy in the eurozone, warned that some banks may need to cut costs further or merge with other banks.

It said some banks might need to shift their business models to different activities to make money in the current environment.

Bank earnings are under pressure from new regulations forcing them to set aside bigger capital cushions and reduce risky activities such as trading securities and derivatives to avoid another financial crisis. Many are also paying fines and legal settlements connected to past misconduct over sales of risky financial products or rigging financial benchmarks.

Banks with disappointing earnings include Deutsche Bank, which lost 6.8 billion euros (currently $7.6 billion) last year and has cancelled its dividend for 2015 and 2016. Profits fell 65 percent at Swiss bank UBS Group in the first quarter. Four smaller Italian banks needed to be bailed out late last year, and big Italian bank UniCredit saw profits fall in the first quarter and its share price has sagged 39 percent so far this year.

Healthy banks are especially important in Europe since all but the largest businesses depend mostly on bank credit. In the United States, credit more often comes from financial markets. The eurozone economy grew 0.6 percent in the first three months of the year, but inflation at minus 0.2 percent annually suggests demand remains weaker than it should be.

Rock-bottom interest rates imposed by the ECB and other central banks squeeze bank profits by reducing the gap between the rates that banks can borrow and the rates they can lend at. The low rates are intended to stimulate weak growth and raise inflation from levels considered too low.

The ECB's policies are further putting pressure on financial institutions by charging a fee on deposits they leave with the central bank. The ECB said, however, that this pressure would be offset by cheap loans the ECB will make available to commercial banks. In some cases, those loans would have negative rates, meaning banks would be paid to take them.