ECB chief economist Peter Praet warns of banking "profitability shock"

Jake Cordell
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The European banking system looks strained in the face of numerous headwinds
The European banking system looks strained in the face of numerous headwinds (Source: Getty)

Eurozone banks should brace themselves for a profitability crisis, the chief economist of the European Central Bank (ECB) has warned today, predicting that the worst is far from over for the industry.

"We have in the sector a severe profitability shock," ECB executive board member Peter Praet told a panel in Brussels this morning.

Banks in the Eurozone have had a rotten start to the year. The Eurostoxx banking index is down 22 per cent so far in 2016, and off more than a third from where it was this time last year.

Read more: London's biggest banks face a profits squeeze

A survey for the ECB last month showed that banks were reporting a tighter squeeze on revenues, but were loosening lending standards in response to the fact they are being charged an annualised interest rate of 0.4 per cent to lodge funds with the central bank overnight.

Praet, who has issued a number of warnings about the health of banks across the Eurozone, added: "In the context of a smaller pool of earnings, you clearly have overcapacity in the sector."

The International Monetary Fund (IMF) has also sounded alarm bells over the health of the industry in the face of market volatility and the pressures of negative interest rates. Last month it warned that one-third of Europe's lenders, calculated by their total share of assets, were facing "significant challenges to attaining sustainable profitability."

Likely suspects Deutsche Bank and Credit Suisse were singled out by the IMF as the most at risk, while Lloyds and Royal Bank of Scotland (RBS) set off alarm bells among the UK banks.

Banks in the periphery of the Eurozone have also struggled. Italy was forced to establish a multi-billion euro rescue fund, Atlante, to provide emergency liquidity to its banks. One third of the fund - or €1.5bn (£1.17bn) - was almost immediately drained when Banca Popolare di Vicenza failed to get funds from the private sector in an ECB-mandated share offering.

Praet said he thinks there may simply be too many lenders across the Eurozone, calling for consolidation and urging for "truly pan-European banks" to be created.

Turning to how well the Eurozone is prepared for the next financial crisis, Praet said he was not entirely convinced it could weather the storm.

"On paper we have much better recovery and resolution processes, but they have not been tested yet. I would still put a question mark on this."