Researchers’ View: On Bank Profits

Feb. 26, 2024

Swedish banks, including SEB, Swedbank, Handelsbanken, Nordea, and Danske Bank, reported record profits, prompting a public debate about whether banks’ earnings are excessively high, and raising questions about competitiveness in the banking sector.

This article features insights from Swedish House of Finance resident researchers, Bo Becker, Paolo Sodini, and Diogo Mendes, who comment on the most discussed aspects of this debate from the perspective of their research fields: Becker offers his perspective from a corporate finance standpoint; Sodini from the household finance viewpoint, and Mendes gives his insights on bank taxation, drawing comparisons with Portugal and other countries.

Here are some frequently discussed talking points about bank profits in the Swedish media, each linked to a source, followed by comments from the researchers.

What drives bank profits?

“Elevated current bank profits reflect two separate facts. First, the business cycle is strong. Although insolvencies are rising and growth seems to be slowing down, so far, banks in many European countries have not yet seen their credit losses increase significantly. As an example, Nordea reported credit losses of 0.1% of the loan stock for 2023.

Second, the rising interest rates have temporarily favored banks. The key reason banks benefit from rising rates is that a lot of their funding is ‘sticky’ as many currently outstanding bonds were issued when rates were significantly lower. For example, Danske Bank has one covered bond maturing in December 2026 with a coupon yield of 0.50% - it was issued in December 2020 when long-term rates were 4-5% lower. Banks tend to lend with variable rates so there is much less stickiness on the revenue side (those companies and households that have fixed rate loans are in as enviable a position as banks).

Note that both factors are temporary. With the weakening business cycle, losses will increase, and as the full stock of funding is rolled over, funding costs will catch up.

A separate question concerns whether banks are too profitable in general. This is much harder to answer. If they are, it's because some markets are not fully competitive. Policy should aim to ensure that (a) new technology and (b) the common European market are harnessed into lower barriers to entry and higher competition.” – Bo Becker

Read the discussion in the media (in Swedish):
“Are the bank profits too high”? on SvD

Should banks be taxed for excess profits?

“The cost-of-living crisis in Europe requires effective responses, with many advocating for banking interventions to ease financial burdens. Several countries, like Italy, Spain, and Slovakia, have imposed windfall taxes on bank profits, mirroring actions taken in other sectors such as utilities due to energy price hikes from the Ukraine conflict.

The success of this response depends on various factors, including each country's specific banking regulation (e.g., in France, there is an anti-usury law that limits the growth of interest rates leading lenders to decline some loan applications or provide them at a loss) and the efficient and fair tax redistribution (e.g., in Lithuania, extraordinary tax revenue is channelled into military investment). Its implementation ultimately depends on the political ideology of the governing bodies.

In Portugal, which is gearing up for polarized legislative elections in March, left-wing parties support a direct market intervention measure through the public bank, Caixa Geral de Depósitos. The idea is for the government as the sole shareholder to intervene directly to lower interest rates on home loans granted by the public bank, which in a competitive setting could lead to lower aggregate financing costs.

The measure lacks support from the major parties in parliament because its potential impact is not obvious. The banking sector in Portugal is composed of few banks, which specialize in different market segments. Furthermore, the dividends paid to the state, now bolstered by extraordinary profits, have contributed to the long-awaited effort of reducing public debt. Finally, it could compromise the lender’s long-term prospects and make it vulnerable.

Although unlikely to be implemented, the proposal has been sufficient to generate a debate about the role of a public bank in society. Should market laws or extra-financial motives prevail?”—Diogo Mendes

Read the discussion in the media (in Swedish):
“Debate: Banks must pay back society” on Dagens Industri

Is the Swedish banking sector competitive?

“Post-pandemic Sweden reached an inflection point in May 2022, when the policy rate finally crossed into positive territory, marking the end of the negative-rate environment that persisted since 2014.

As most of Swedish homeowners have adjustable-rate mortgages, this new regime meant that many households found it harder to service their mortgages. Today, new homeowners are being offered mortgages at rates above 5%, a number unheard of since 2006-2009. At such a time, news of increasing net interest margins at the very banks that originated your loan is bound to raise concerns about anti-competitive behavior.

However, the spread between mortgage rates and short-term government bonds is today about 1%, which is the lowest on record since 2009 and half of what it was 5 years ago. This spread essentially measures the difference between what banks charge borrowers for mortgages and what they pay for borrowing money (represented by the yield on short-term government bonds), so looking at the mortgage market, it does not seem that the banking sector has become less competitive as of lately. If there are oligopolistic rents in the mortgage market, they must have been there already more than 15 years ago.”—Paolo Sodini

Read the discussion in the media (in Swedish):
Adam Cwejman : Swedish banks need a revolution- Göteborgs Posten