UBS Chairman Axel Weber warned on Tuesday that the beleaguered European banking sector was still facing many challenges, particularly on the regulatory and capital front, and that the European Central Bank (ECB) was likely to wait and see how its policies do before changing course.
"Markets are still difficult, you can really see that the support that equity markets had, in particular, through very expansionary monetary policy, is fanning off. Global liquidity is still in a very difficult place and we're seeing people adjust portfolio positions," Weber told CNBC on the sidelines of the International of International Finance (IIF) meeting in Madrid.
"Given the uncertainty in markets, many of our clients are stepping away from trading. Even in wealth management, the uncertain environment means that a lot of the clients sit on cash and avoid long-term decisions and really are not very active and that's a very difficult model to be in….It's a difficult environment still."
Europe's banking sector saw a turbulent start to the year when banking stocks took a bruising in markets on concerns of their profitability, exposure to slumping energy prices, regulatory hurdles and fears over non-performing loans in some banks, particularly those in Italy.
First quarter earnings from several large banks including Deutsche Bank, Credit Suisse, HSBC and Commerzbank showed sharp falls in profit. On Tuesday, Moody's ratings agency downgraded Deutsche Bank's ratings but said the outlook was stable. Despite the gloomy start to the year for the region's banks, Weber said he hadn't "written the year off."
"This year there is huge uncertainty in global markets, major political decisions to be taken in the U.S. (with the presidential election in November) and U.K. (with the referendum on European Union membership), so I think a lot of people are waiting for that dust to settle. So that gives me hope that the second half of the year will see more activity (from clients)…but at the moment the indicators are still that the market is difficult."
Regulatory challenges
Earlier on Tuesday, the IIF's President and Chief Executive Tim Adams told CNBC on the sidelines of the forum that the biggest threat to Europe was the undercapitalized banking system.
"Banks are struggling against a whole host of challenges: the flat yield curve, negative interest rates, new entrants, regulatory burdens – it's a tough time for European banks." Adams added that the "regulatory issues just don't seem to stop."
"We've got to find a way to recapitalize banks but do so in a way they can afford it. The biggest threat to financial stability is unprofitable banks in Europe, we've got to make sure we have healthy, profitable banks," he said.
Weber agreed that he worried about how regulation, such as that which requires banks to hold a certain amount of core capital as a buffer against financial shocks, could affect banks' profitability. "I'm not concerned about levels of capital in the sense that there could be a solvency issue. I'm more concerned about the additional capital that some banks might need to raise and what that will do to the European banks' profitability given the weak growth environment."
ECB to hold fire
The ECB has increased its already massive stimulus program, including rate cuts and asset purchases, in a bid to stimulate growth, lending and restore inflation to the region while prices remain low and far from the bank's near-2 percent target. The last inflation reading in April revealed that the region had fallen back into deflationary territory.
Weber did not think that the central bank would change its strategy or even start to think of tightening its monetary policy yet.
"Europe is in a totally different place (to the United States). The economy is still very weak and we don't really see a lot of growth on the horizon, in that environment I think it would be a mistake for the ECB to tighten. I see them more firmly on hold at the moment to see if these more drastic measures they've taken will work out."
Follow CNBC International on Twitter and Facebook.
Correction: An earlier version of this story provided an incorrect spelled-out form of the IIF acronym. It stands for the Institute of International Finance.