Drivers of bank profitability in the euro area

Bank profitability matters for financial stability and for monetary policy transmission. At the same time, bank profitability is affected by monetary policy decisions and by the broader macroeconomic environment. Over the past years, macroeconomic conditions have changed fundamentally. From being too low, inflation became far too high, triggering a strong tightening of monetary policy. The related rapid increase in interest rates has had different consequences for banks depending on their jurisdictions and regulatory environment and on their business models. Focusing on the euro area, this chapter explores the drivers of bank profitability and highlights how changes in macroeconomic conditions can affect it. The analysis is based on a vast dataset of bank-level data over 2009-2022 and uses a framework based on quantile regressions. This econometric tool allows us to account for bank heterogeneity when analysing the drivers of bank profitability and to infer the probabilistic distribution of the profitability of a representative euro-area bank. The analysis allows us to assess how the profitability of this representative bank may respond to different economic shocks, with a focus on shifts in the interest rate environment economic activity and NPL ratios. We find that the average bank profitability is driven by the level of the shortterm interest rates in the sample. Hence, we find that the recent steep increase in short-term interest rates benefits bank profitability. However, a macroeconomic shock of a size similar to the one faced during the financial crisis would negatively impact bank profitability, despite the higher level of interest rate.