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Mr. Selim A Elekdag, Sheheryar Malik, and Ms. Srobona Mitra
This paper explores the determinants of profitability across large euro area banks using a novel approach based on conditional profitability distributions. Real GDP growth and the NPL ratio are shown to be the most reliable determinants of bank profitability. However, the estimated conditional distributions reveal that, while higher growth would raise profits on average, a large swath of banks would most likely continue to struggle even amid a strong economic recovery. Therefore, for some banks, a determined reduction in NPLs combined with cost efficiency improvements and customized changes to their business models appears to be the most promising strategy for durably raising profitability.
International Monetary Fund. Monetary and Capital Markets Department

income. However, higher long-term interest rates would reduce the valuations of longer-term securities (that are held in the available-for-sale portfolio for instance). Since the crisis, the maturity of such securities held by banks have gone up, and so the valuation effects are sizeable even as net interest income improves with higher long-term interest rates. Furthermore, higher interest rates could push highly indebted bank borrowers to default on their loan payments that would increase provisioning costs and decrease profitability. Likewise, bank profitability and

Mr. Selim A Elekdag, Sheheryar Malik, and Ms. Srobona Mitra

between lending and funding rates. All else equal, a steeper yield curve would raise net interest income. However, higher long-term interest rates would reduce the valuations of longer-term securities (that are held in the available-for-sale portfolio for instance). Since the crisis, the maturity of such securities held by banks have gone up, and so the valuation effects are sizeable even as net interest income improves with higher long-term interest rates. 19 Furthermore, higher interest rates could push highly indebted bank borrowers to default on their loan payments

International Monetary Fund. Monetary and Capital Markets Department
This technical note consists of five chapters focusing on various aspects of systemic risk analysis across the euro area financial system. The chapters cover bank profitability, balance sheet- and market-based interconnected analysis, contingent claims analysis, and a brief discussion of data gaps in the nonbank, non-insurance (NBNI) financial sector. The ongoing economic recovery will support euro area bank profitability in general, but it is unlikely to resolve the structural challenges faced by the least profitable banks despite some recent improvements. This is important because persistently weak bank profitability is a systemic financial stability concern. Empirical analysis of 109 major euro area banks over 2007–2016 reveals that real GDP growth and the NPL ratio are the most reliable determinants of profitability, after accounting for other factors. Although higher growth would raise profits, a large swath of banks with the weakest profitability would most likely continue to struggle even with a robust recovery. Therefore, banks should take advantage of the current upswing by resolutely addressing their NPL stocks—such a strategy holds the most promise for weak banks’ profitability prospects.