European banking industry's provisions for bad loans are lower than expected, strong employment supports the economy unfazed by weakness.

The provisions for non-performing loans set aside by large European banks are lower than expected, despite weak economic growth in Europe, as the resilience of the labor market effectively offset the pressure from economic softness. Bloomberg Intelligence analyst MarYana Vartsaba pointed out that before the release of second-quarter financial reports, analysts had expected banks to indicate deteriorating credit quality due to the slowdown in economic growth being factored into models calculating potential loan defaults. Earlier this year, banks such as Barclays and Deutsche Bank set aside more provisions for non-performing loans than expected due to tariff uncertainty and a sluggish macroeconomic environment, but quickly adjusted their strategies. Based on banking data covered by Keefe, Bruyette & Woods (KBW), analysts calculated that overall loan loss provisions in the second quarter were 10% lower than expected. KBW European banking research director Andrew Stimpson stated, "We originally expected many banks to reflect 'Oh my, GDP growth is far below expectations,' but the anticipated impact of sluggish economic output was offset by strong employment data. Therefore, as long as everyone has a job, even if economic growth slows down a bit, the situation won't be too bad." Stimpson and Jefferies analyst Joseph Dickerson both believe that factors such as maintaining low unemployment rates, lower exposure of European banks to commercial real estate compared to the U.S., the deleveraging efforts in the years after the financial crisis, and moderate loan growth have collectively contributed to this positive surprise. Asset quality remains resilient European banks still have some provisions built up as a buffer post-COVID, estimated by Bloomberg Intelligence's Vartsaba to be around 10 billion euros, which can be used to mitigate the risk of potential rise in non-performing loans. The rate cut also provides support to credit quality: the European Central Bank cut the deposit rate to 2% in June, the lowest level in over two years. All of this indicates that asset quality will remain resilient in the coming quarters. Dickerson stated that credit quality may only deteriorate across the board in the event of "significant turmoil" in the economy and a rise in unemployment rates. However, this does not mean that all banks are invulnerable. HSBC Holdings set aside $400 million in provisions for commercial real estate loans in Hong Kong in the second quarter and increased its risk cost guidance. This news overshadowed the positive impact of exceeding profit expectations, putting pressure on the stock price. Overall, the credit quality continues to be robust, net interest income remains resilient, and trading income steadily grows under volatility, helping European banks outperform other sectors in this earnings season. In the second quarter, the MSCI Europe Financials sub-index reported a profit growth of 15%, significantly higher than the expected 1.8%, the largest outperformance among all sectors. Loan growth becomes a new driver Stimpson stated that although the outperformance trend of European banks is expected to continue, new catalysts are still needed, and loan growth is key: "We are starting to see an increase in loan growth, which is crucial for both the banking sector and the overall economy." Bloomberg Intelligence's Jeroen Julius and Ruben Benavides pointed out that although the economic outlook is unclear, second-quarter European bank deposits grew by 2% and loan growth rate returned to 3% due to improving loan demand. Stimpson said, "The emerging loan growth is a key factor that has not yet been reflected in stock prices and valuation multiples."