Rising interest rates mean borrowing costs are rising, which could benefit banking stocks. However, Lombard Odier says that while there are some benefits from rising interest rates, banks are also facing recession risks.

Stéphane Monier, Chief Investment Officer of Lombard Odier Private Bank, says that banks typically earn money from the net interest income, and they pass on rate hikes mainly to borrowers, increasing their profits.

In Europe, banking stocks have been on the back foot due to negative interest rates which eroded revenues. But the rising rates have helped European banks to post revenue growth of 8%. In the US, banks are already close to their ‘peak’ earnings and cost inflation is running high.

However, Lombard Odier says that investment banking businesses are facing a tough time. “In Europe, market volatility has also exposed vulnerabilities in some individual stocks, where the probability of capital increases has risen,” writes Monier.

The bank sees a recession in Europe and US in 2023, and bank asset quality is likely to deteriorate as loan growth slows and defaults rise. But banks in Europe and the US seem ready for economic headwinds.

Lastly, the biggest risks for banking stocks are the recession, one-off taxes and the reserve requirements set by the European Central Bank.

Banking stocks are on a strong fundamental footing and rising interest rates will aid earnings growth. Lombard Odier says that valuations look very attractive at present, but a positive earnings outlook has not yet helped the share prices of European banks.

“We retain our preference for those with sound balance sheets, strong capital levels and the potential for capital return – the latter more likely to be found in Europe than in the US,” says Monier.

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