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Annual review: Banks bounced back in 2021, but challenges remain

NatWest Bank branch sign

After a dreadful 2020, when bank stocks here and in Europe hit record lows, the outlook improved heading into 2021, as the vaccine rollout gathered speed. That said, banks still had to grapple with the uncertainty of a third national lockdown from 6 January, Bank of England forecasts for a 4% contraction in Q1 GDP, and talk of negative interest rates.

The possibility of negative rates threatened to dent banks’ profitability. The timing was unhelpful, as there is no clear evidence that sub-zero interest rates work, especially in an economy enduring a lockdown. In Europe and Japan, where negative interest rates have been implemented, the move has proven ineffective, and has arguably made matters worse.

In the first two months of the year, as optimism around the vaccination programme ran into concerns over the impact of another lockdown, travel restrictions and vaccine supplies, European and UK banks hit their lowest point of 2021, as the chart below shows.

Comparison: UK, US, and EU banking basket (2021)

Source: CMC Markets

Since those January lows, European and UK bank stocks have moved higher. European banks outperformed their UK counterparts, partly because the European banking sector fell to a lower base than the UK banking sector in 2020.

The European outperformance is also related to the index’s weighting towards Spanish banks, which did more than their peers to address the problems of non-performing loans.

When the pandemic hit, banks stockpiled cash to cover a potential spike in loan defaults. According to data released by S&P Global in April, the biggest provisions for possible pandemic-related loan losses in 2020 were set aside by Banco Santander, Bilbao Vizcaya, and French bank BNP Paribas, who between them allocated over €23bn.

UK banks also set aside considerable amounts to deal with the prospect of possible loan defaults. HSBC led the way, setting aside more than $8.8bn, or £6.5bn. Barclays came next on £4.8bn, followed by Lloyds Banking Group with £4.25bn and NatWest Group on £3.24bn.

UK banks’ share prices recovered this year, partly because the expected rise in loan defaults during the pandemic didn’t materialise, at least not to the extent that banks had feared . This meant that UK banks, following in the footsteps of US banks, began drip-feeding their emergency cash stockpiles back onto their balance sheets. Another key feature of this year’s recovery in bank share prices was the restoration of dividends.

The banks that performed best this year also benefited from the early-year volatility in stock markets, which their investment banking operations were able to take advantage of. Increased revenue from M&A and IPO fees were a key driver of profits for the larger UK banks with global operations.

UK banking headwinds

The UK banking sector underperformed relative to its European and US peers for the second consecutive year in 2021. While this was partly due to the Bank of England’s unhelpful speculation about negative interest rates around the turn of the year, that doesn’t explain UK banks’ underperformance in the second half of the year. It seems clear, then, that concerns over a UK-EU trade fissure stemming from disagreements around the Northern Ireland protocol also played a part. Additionally, the tax increases signalled in the autumn budget dampened business confidence.

UK banks' performance (2021 YTD)

Source: CMC Markets

Nonetheless, while the sector’s year-to-date performance has been disappointing, we’ve seen encouraging numbers from the likes of Lloyds and NatWest. That’s despite these banks being more UK-focused than Barclays and HSBC, whose investment banking divisions provide international revenue streams. For instance, HSBC generates more than two-thirds of its profits in Asia, according to a company report released in December 2019. 

As the chart above shows, the best performers have been Barclays, Lloyds and NatWest. Their price movements broadly aligned for most of this year, as a recovering UK economy and increased mortgage lending drove growth in profits. 

NatWest Group

Shares in NatWest hit a record low in 2020, but rebounded to pre-lockdown levels in 2021. Although the NatWest share price has performed well this year, it remains below the 250p mark that it last reached in December 2019.

CEO Alison Rose has steadied the ship but NatWest is still paying for legacy issues. The bank was charged £294m after pleading guilty to three criminal charges of money laundering in November.

NatWest’s numbers have improved, despite the lockdowns that hampered the economy in the first half of this year, as the bank released funds from its loan-loss provisions pot, boosting profits in every quarter this year. All this suggests that NatWest may finally be turning a corner. The UK government has re-started the process of reducing its stake in the bank.

In Q1, NatWest released £102m in loan-loss reserves onto its balance sheet, helping lift profits to £620m. Profit growth was also fuelled by a big increase in mortgage lending to £9.6bn, while customer deposits also rose by £7.3bn from Q4 of the previous year.

In Q2, the bank released another £605m from reserves, helping to boost Q2 pre-tax profit to £1.22bn and resulting in half-year profits of £1.84bn. The bank resumed dividend payments, declaring an interim dividend of 3p per share. The bank also announced plans to buy back £750m of its own shares in the second half of the year, after the Bank of England removed restrictions on payouts a few weeks previously. This will mean a nice windfall for the UK government as it looks to pare back further its 54% stake in the lender over the course of the next 12 months. The bank says it expects to distribute a minimum of £1bn a year to shareholders from 2021 to 2023 via a combination of ordinary and special dividends.

In Q3, the picture remained positive, with profit attributable to shareholders beating expectations to come in at £674m. This was above last year’s £61m, but was only around half the Q2 figure. The bank released £242m from its non-performing loan pot, bringing the year-to-date total to £949m. The bank is well ahead of where it was a year ago, with year-to-date profits at £2.5bn, compared to a £644m loss over the same period in 2020. However, the bank continues to struggle on net interest margins, which fell to 1.54% in Q3 from 1.61% in Q2. In terms of lending and client activity, NatWest’s net loans to customers rose to £180.5bn. Personal loans and credit card lending was a little subdued, but still rose by £100m, possibly reflecting a willingness among consumers to spend more money as the economy reopened over the summer.


Barclays was a little more cautious than NatWest when it came to releasing loan-loss reserves at the beginning of the year, partly because the bank’s total income in Q1 fell 6% to £5.9bn. The Q1 numbers demonstrated that CEO Jes Staley was correct to push back against activist shareholder Ed Bramson, who had urged management to slim down investment banking operations. While the division may have its weak spots, investment banking gives Barclays a revenue stream that some of its more domestically focused peers lack .

In Q2 the bank fared much better than in Q1, releasing £742m from reserves and boosting profits before tax to just under £5bn in the first half of the year, well above forecasts. The bank said it would pay a dividend of 2p a share, and buy back £500m of its own shares. Investment banking helped drive this outperformance, with the division’s pre-tax profit rising to £1.58bn, above estimates of just over £1bn, largely thanks to a 19% increase in M&A fees. The UK business performed well, helped by a modest rise in customer deposits and customer loans, though credit card lending declined from the end of last year – a trend that continued into Q3. Indeed, these themes – increases in customer deposits and personal lending, particularly mortgages, and decreases in credit card and business lending – have played out across the banking sector this year.

In Q3, Barclays released a further £622m from its loan-loss reserves, as pre-tax profits grew to £1.5bn on revenue of £3.1bn. These results helped lift the Barclays share price to a three-year high in October.

Lloyds Banking Group

With Lloyds Banking Group’s fortunes closely linked to the fortunes of the UK economy, there were concerns over how the bank might cope with national lockdowns, particularly with regard to the possibility of loan defaults.

At the start of its financial year the bank was therefore understandably cautious, saying that the outlook was highly uncertain given that the latest lockdown could place more of its customers in financial difficulty in the months ahead. However, it still felt confident enough to resume its dividend. As it turned out, Lloyds needn’t have worried. The company posted a Q1 statutory profit of £1.4bn, beating expectations, partly thanks to the release of £323m in loan-loss provisions.

In July the bank raised its outlook for the year after reporting a Q2 statutory pre-tax profit of £2bn, bringing half-year profit to a better-than-expected £3.9bn. Profits were boosted by the release of a further £333m from the bank’s emergency stockpile. The performance of the underlying business also improved, as net interest margin rose to 2.51%. On the customer side, mortgages increased by £7.5bn to £447bn over the six-month period, while deposits grew by £23.7bn to £474.4bn. SME and corporate lending declined in Q2, suggesting that businesses were reluctant to spend. Lloyds announced that it would pay a dividend of 67p, and confirmed the acquisition of savings and pensions firm Embark Group for £390m.

In Q3, Lloyds bank posted another strong set of results , with profit after tax coming in at £1.6bn, almost £1bn higher than a year ago. This pushed profit for the year to date to just under £5.5bn. A further £84m was released from loan-loss provisions, as the economic outlook improved, taking the amount Lloyds has released this year to £740m. Having posted strong quarterly results throughout this year, a robust Q4 could see Lloyds increase its dividend.


HSBC also resumed its dividend after reporting full-year numbers in February, paying $0.15 a share, as the bank continued to reorientate its business towards Asia , which contributes the bulk of its profits.

In Q1 HSBC posted decent results, with profit after tax up 79% to $4.5bn, as the bank’s balance sheet was boosted by the release of $400m from money set aside in 2020 to cover potential loan defaults. Despite the rise in profits, Q1 revenue fell 5% year-on-year to $13bn, partly due to the low interest rate environment.
The bank’s Q2 numbers followed a similar pattern – profits after tax of $3.85bn were better than expected, but revenue was lower than a year earlier, mainly because interest margins across the bank’s global operations fell from 1.43% a year ago to 1.21%. The headline numbers were helped by the bank releasing a further $300m from provisions for non-performing loans.

With half-year profits after tax totalling $8.4bn, the bank announced an interim dividend of $0.07 a share. The UK operation had a good half-year, contributing profits of $1bn in Q1 and $1.1bn in Q2.

In Q3, HSBC again posted a strong set of numbers, as profits after tax almost doubled to $4.2bn, taking year-to-date profits to $12.66bn. Q3 revenue grew 1% year-on-year to $12bn, but was down slightly compared to Q2. All areas of the bank improved, including the UK business which contributed $1.5bn of profits before tax. The Asia business contributed $3.3bn. Profit before tax of $5.4bn was boosted by the release of a further $700m in bad debt provisions, taking the amount released year-to-date to $1.4bn. The bank announced a $2bn share buyback but, unlike in Q1 and Q2, the bank didn’t pay a dividend in Q3. In line with other banks, HSBC’s lending was subdued, with net loans and advances to customers falling in Q3. Global Banking and Markets saw a modest decline in adjusted revenue to $3.6bn in Q3, with net interest margin remaining steady at 1.2%, below the 1.35% recorded a year earlier.

Banks had a decent 2021, but headwinds remain

To sum up, 2021 was a decent year for banks in general, after the record lows of 2020. The outlook is much more positive now, with the vaccination and booster programme helping to keep the economy open as things stand. The low level of bankruptcies and loan defaults was a boon for the banks during 2021, but headwinds remain. Rising inflationary pressure may be good for bank margins, but could well impact consumer borrowing patterns, particularly in mortgage lending, which has been strong. Central banks will remain under pressure to contain rising inflation expectations next year .

The broader economic recovery is already showing signs of slowing as winter approaches, with consumers in the UK, Europe and the US facing higher food and energy costs. It remains to be seen how transitory these price rises are, and to what extent consumers can absorb higher living costs. Answers to these questions will determine whether the banks can maintain their current positive momentum, improve their profit margins and continue to pay decent dividends.

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