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Breakingviews

Breakingviews - Bank investors blithely bet on benign EU lockdowns

A man crosses a footbridge over the River Thames, amid the outbreak of the coronavirus disease (COVID-19), on the first day of a newly imposed lockdown, in London, Britain November 5, 2020. REUTERS/Toby Melville

LONDON (Reuters Breakingviews) - European bank investors seem relaxed about the latest lockdowns. The STOXX Europe 600 Banks Index, which includes major lenders based in the United Kingdom and on the continent, has risen 6% in the past month, despite the introduction of quarantines in Germany, Britain and France. There’s logic to the idea that banks will be resilient, but it’s nonetheless optimistic.

One lesson from the first coronavirus wave was that big lenders’ earnings and capital held up fairly well in the face of rising bad debt, falling interest rates and a shrinking economy. BNP Paribas, Deutsche Bank and Lloyds Banking Group generated enough pre-provision operating profit in the first nine months of 2020 to absorb their dud-credit charges. They also reported higher common equity Tier 1 (CET1) capital ratios for the end of September than in March.

On paper, another month-long lockdown might not change much. Assume pre-provision profit stays flat in the fourth quarter from the relatively muted third-quarter level. Next assume that bad-debt charges come in at the average level of the previous three quarters – a period that spans the much higher losses seen in the spring. Deutsche and BNP would still churn out a pre-tax profit, while Lloyds would roughly break even in the final three months of the year. In other words, CET1 ratios remain intact even using bearish assumptions.

Further comfort comes from the fact that the latest measures look shorter and milder. German Chancellor Angela Merkel, and her British and French peers Boris Johnson and Emmanuel Macron, announced lockdowns under which much construction and manufacturing activity could continue. The incremental hit to GDP should therefore be less severe than in the spring. That implies a smaller rise in bad-debt provisions when banks feed the new economic forecasts into their credit-risk models.

The problem, however, is in assuming that the current measures will be the last. Hopes of a “V-shaped” recovery have turned pear-shaped in recent months, as reopenings led to rising infections, necessitating new lockdowns. Absent a vaccine or effective track-and-trace systems, this could become a cycle. Big banks’ capital levels might be able to withstand repeated mini-lockdowns, but the accompanying bad-debt charges would keep eating into earnings – rather than tapering off from 2021, as investors currently expect. As with sufferers of “long Covid”, the virus’s symptoms could prove a persistent complaint.

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