European banks inch towards high-rate cliff edge

Lloyds Banking

14/10/2026 11:27

The author is a Reuters Breakingviews columnist. The opinions expressed are his own.
By Liam  Proud
LONDON, Oct 14 (Reuters Breakingviews) - Investors seem to think that rising interest rates have become too much of a good thing for European banks. Shares in the region's 20 largest lenders by assets have dropped 7% since early August, a period in which government bond yields have spiked due to fiscal worries and fears of higher oil-driven inflation. There is indeed a level past which high rates become a net negative for banks, but it's not too close yet.
French lenders BNP Paribas BNPP.PA, Crédit Agricole CAGR.PA and Société Générale SOGN.PA have seen the steepest falls, losing 20% of their value on average since August 3. That's perhaps unsurprising given the country's brewing debt crisis. Still, the share-price pain transcends the Gallic trio. Britain's Lloyds Banking Group LLOY.L, NatWest NWG.L and Barclays BARC.L fell 11% on average over the same period, while Italy's UniCredit CRDI.MI and Intesa Sanpaolo ISP.MI dropped 8%.
There is logic to the selloff, which inverts the usual rule of thumb whereby higher interest rates help lenders. First, steeper borrowing costs mean households and companies are less likely to seek credit. Indeed, euro zone loan growth slowed to zero at the end of 2023 - a year in which the European Central Bank hiked its deposit facility rate by 2 percentage points. Second, rising rates increase the risk of customers shopping around for a better deal on their deposits, squeezing interest margins. Finally, they can also lead to extra loan defaults and losses on European banks' government bond holdings.
Each of those dangers is manageable. For one, central banks seem unlikely to raise rates as high or as fast as in 2023. Market prices tracked by LSEG imply that ECB rates will end 2027 at 3.25%, just 0.75 percentage points higher than now, and that the Bank of England will stop at 4.75% - a 1 percentage point hike from today. Those changes are far smaller than the rapid post-pandemic increases that killed loan growth. It's also unclear why these relatively modest changes would make customers drastically more likely to shop around for better yields.
And while bad debt is always a risk, especially if higher rates cause job losses, it's hard to see dud loans cancelling out the benefits of high rates. Take Deutsche Bank DBKGn.DE, which discloses the ways in which changes in different macroeconomic variables would impact its model for calculating expected credit losses. A half-percentage point rise in unemployment across its key markets would boost provisions against performing loans by just €50 million. For context, its pretax profit this year will total some €10 billion, Visible Alpha data shows. And forecasters surveyed by the ECB in July expected euro zone unemployment to fall, not rise.
Even for the Gallic banks, potentially most at risk of government debt losses judging by recent bond-market moves, the pain from higher rates seems manageable. JPMorgan analysts reckon that a 100 basis point rise in the spread between French and German debt reduces French banks' common equity Tier 1 ratio by just 4 basis points.
Moreover, the recent selloff has given investors a margin of safety. The sector's average valuation multiple has compressed by a tenth since early August to less than 1.6 times forward tangible book value. Higher rates, for now, need not keep European bank investors up at night.
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CONTEXT NEWS
Shares in the 20 biggest Europe-focused banks, judged by total assets, have on average dropped 7% since the start of August. The wider STOXX Europe 600 Index fell 2% over the same period.

(Editing by Neil Unmack; Production by Oliver Taslic)
((For previous columns by the author, Reuters customers can click on PROUD/liam.proud@thomsonreuters.com))