Global investment banks risk seeing their annual profits wiped out by the coronavirus crisis, with European banks more vulnerable than their more profitable US counterparts.

Even the most optimistic “rapid rebound” scenario, where relative normalcy is restored in six months or less, could lead to a 100% decline in earnings this year, according to a new report co-authored by Oliver Wyman and Morgan Stanley.

In a more pessimistic model – dubbed a “deep global recession” and lasting a year or more – some weaker banks would collapse and suffer heavy losses. In this scenario, credit losses could reach between 200 and 300 billion dollars, compared to 30 to 50 billion dollars in the event of a rapid rebound.

While the banking sector has built up strong buffers of capital and liquidity since the financial crisis, “yields have never been lower in the run-up to a major crisis event and banks’ first line of defense is profitability before provision,” said Morgan Stanley’s Magdalena Stoklosa, who led the report alongside Oliver Wyman’s James Davis.

“Earnings pressure could expose structural weaknesses in some business models [ . . .] the performance gap will be significant,” Ms. Stoklosa said. “The biggest driver of profitability is scale,” meaning an increasingly dominant Wall Street – where JPMorgan is the most profitable lender – is likely to use the crisis to take more market share to small European lenders.

Germany’s troubled Deutsche Bank and Commerzbank are the worst placed among the big banks, with little or no profits to absorb a wave of defaults. Meanwhile, Credit Suisse and UBS are the European lenders best positioned to cope, thanks in large part to their shift from investment banking to wealth and asset management.

Amid the turmoil caused by the lockdowns imposed to contain the pandemic, the resilience of banks is under close scrutiny. A record number of businesses have been forced to apply for state aid.

Governments and central banks have unveiled measures to support lenders, including freeing up $500 billion in capital by temporarily easing regulations and pumping billions in cheap funding into the system.

Despite all the help, “we’re still talking about an ugly earnings scenario rather than banks plunging below their capital requirements,” Ms Stoklosa said.

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Over the past five years, wholesale banks have generated an average return on equity of 9-10%, according to the report. In the best-case scenario, this measure of profitability will halve to 4-5% between 2020 and 2022 – well below the 10% targeted by investors – with weaker lenders dropping to zero or below.

The eurozone banking system entered this crisis in a particularly weakened state. A study by the European Central Bank last week showed average yields fell to 5.2% in 2019, less than half that of their US counterparts.

The performance will “intensify calls for significant strategic change, potentially also acting as a catalyst for consolidation among European and Tier 2 players,” the report says.

Unlike the 2008 financial crisis, banks can no longer offset falling profits by cutting billions of dollars in costs, as fixed regulatory, compliance and IT costs have piled up.

Additionally, “in the midst of a public health emergency, banks are unlikely to continue cost-cutting by imposing layoffs,” the report said. HSBC has already announced it will delay the “vast majority” of layoffs as it restructures. Some banks may be pressured to sell assets or exit lines of business to breathe, the report adds.

Within investment banking, a slowdown in trading and capital markets should be partially offset by increased trading revenue during the initial volatility. Meanwhile, transaction banking and securities services will be impacted by record global interest rates that will eat into their margins.

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