The party is over

Chart 1: Key financial figures for Q4/2023. Source: The sample banks’ Q4/2023 interim reports. FX rates as of 31 December 2023. Source: https://www.ecb.europa.eu/stats/policy_and_exchange_rates/html/index.en.html.

For the full-year 2023, the banks delivered a ROE of 15.0% – up from 10.0% one year ago and representing an improvement of 50% year on year – and C/I of 39%, down from 50% and an improvement of 22% compared with 2022. The main driver behind the improved profitability and efficiency was the higher net interest income, up by 30–40% for most banks.

A decade’s view

As we report these significant improvements in the banks’ short-term performance, we want to put them into a broader perspective and look at how they compare with the banks’ results during the past 10 years. Our first observation is that both lending and income of the large Nordic banks grew in lockstep at a quite moderate compound annual growth rate (CAGR) of 2.5% during 2014–2022. It was only last year when income growth rocketed into new hights (due to the reasons explained above) and separated from the lending growth trajectory.

Based on these data, we can conclude that the large Nordic banks predominantly engage in traditional, balance-sheet reliant business⁵ that is significantly dependent on the interest rate levels. Most large Nordic banks follow a conservative risk management approach with very little risk taking outside of their core lending and deposit-taking businesses. The only exception within the group in recent years has been Danske, running a major trading business, but following the business line’s loss-making Q2/2022, it too has been de-risking its trading portfolio during the past year. As a result, we can now say that as the interest rates go, so goes Nordic banking too.

Chart 2: The sample banks’ loan and income growth during 2014–2023. Loan growth is measured by loans to the public and income growth is measured by total income. Indexed, simple averages and annual figures in the reported currencies are used. Source: The sample banks’ annual reports.

When looking at the banks’ profitability and efficiency during the past decade, we observe a relatively steady ROE of 10–11% and C/I of 47–50% during 2014–2022.⁶ As explained above, figures for both ROE and C/I improved exponentially in 2023 (to 15% and 39%, respectively).

Chart 3: The development of the sample banks’ ROE and C/I during 2014–2023. Simple averages and annual figures are used. Source: The sample banks’ annual reports.

This seems to indicate that in a low interest rate environment, even the best banks in the world (as we like to call the large Nordic banks⁷) have a ceiling for their profitability and efficiency, that is, if they avoid adding more risk to their operations.

The here and now

In the current environment, with Nordic central bank⁸ policy rates at 3.75–4.5%, the banks operate at their long-term profitability target levels⁹. Given the downturn in the banks’ business momentum in the last quarter of 2023, the big question is: Can the banks maintain their current level of performance this year and beyond?

As we noted in our previous report, we foresee headwinds for the banks in 2024, mainly due to lower interest margins, higher expense levels and rising loan losses. We have already witnessed the first two of these forces picking up. Should the Nordic economies continue weakening, higher loan losses might follow, pressuring the banks to focus on operational efficiency which de facto equals introducing cost-cutting measures as means to meet their commitments to the capital markets.

It is too early to say whether this is indeed the path that the large Nordic banks are on right now, but we repeat our earlier recommendation: Keep your costs under control to avoid risking your long-term development needs (i.e. technology modernisation, improved operational risk management and the sustainability transition). At the same time, we recognise that most of these banks are publicly listed and as such, must balance their investors’ short-term and long-term return expectations. These are often not without complications and might require the banks to re-assess their development agendas. To do this effectively, the banks will need to follow a rigorous, yet agile, portfolio prioritisation anchored in their strategic goals and priorities. This is the only way to ensure the banks stay on track to meet their long-term aspirations while executing necessary short-term tactical moves.

_________________________________________

¹ https://www2.deloitte.com/fi/fi/blog/finland-blog-homepage/2023/nordic-banking-insights-q3-2023.html

² Nordea Bank, Danske Bank, Skandinaviska Enskilda Banken (SEB), Svenska Handelsbanken (SHB), Swedbank, DNB, Nykredit, OP Financial Group (OP)

³ Total income was lower for 5/8 of the banks quarter on quarter and expenses higher for all of them.

⁴ Common Equity Tier 1

⁵ This is no major surprise as the banks themselves state the same, with some exceptions.

⁶ In 2020 the bank results suffered, mostly due to discretionary loan loss provisions put aside because of Covid-19 under the expectation of eventual loan defaults that would follow rather than being due to any actual weakness in the banks’ underlying business performance. These provisions were never used for their original purpose and still largely exist on the banks’ books, but have since been repurposed.

⁷ https://www2.deloitte.com/fi/fi/blog/finland-blog-homepage/2023/nordic-bank-insights-q4.html

⁸ Including the European Central Bank for Finland.

⁹ For Nordea, SEB, SHB and Swedbank, the target is a ROE of 15%, and for Danske and DNB, it is 13%. As non-listed companies Nykredit and OP operate under a different business philosophy that does not emphasise profitability. Hence, their targets are not considered relevant here, even while they exist and both banks have already reached and exceeded those.