Low banking profitability across the euro zone raises stability concerns and lenders need to stop taking on bigger risks to prop up earnings, Daniele Nouy, the European Central Bank's top supervisor said on Tuesday.
Weak earnings threaten banks' ability to generate capital and access financial markets, a stability risk that is exacerbated by a sometimes "hazardous" search for yields, Nouy told a banking conference in London.
Regulators are running checks on major European banks this week to see how resilient they are to possible economic and other threats.
Banks' net interest margin has halved over the past two decades, taking a fresh hit in recent years after the European Central Bank cut its key rate into negative territory. Margins are expected to remain under pressure for an extended period on weak growth and ultra-low rates.
"We do observe a trend towards higher risk-taking by banks," Nouy said. "In its search for yield, the financial sector has apparently ventured into riskier territories, driving risk premia to historic lows."
"This situation harbors the potential for an abrupt reversal that could be exacerbated by illiquidity in some segments of fixed-income markets," Nouy said, mentioning increases investments into high-yield bonds as a specific example.
The ECB has forced banks to build buffers for years but said they now have ample capital and the supervisory focus is now shifting to reforming operations.
Banks could instead expand their non-interest business operations, raising their fees or replacing fee-based products as substitutes for interest-based products.
Another option for banks would be to cut their costs and increase their efficiency, Nouy added.
"Over the long term, low profitability threatens the ability of banks to generate capital and access financial markets," Nouy said. "Ultimately, a lack of profitability affects the stability of banks."