The International Monetary Fund warned Wednesday that European banks cannot solely rely on a cyclical recovery to shrug off their problems.
A combination of weak profits, lack of access to private capital and large debt burdens could spark further concerns over the stability of the financial industry, the Fund said in its latest Global Financial Stability report.
"A cyclical recovery will likely be insufficient on its own to restore the profitability of persistently weak banks," the Fund said. Domestic banks are under particular stress given that nearly 75 percent of them had weak returns in 2016.
According to the IMF, one of the main problems in Europe is overbanking - which means that there are too many banks for the number of customer available.
"These features can result in limited lending opportunities or a high number of branches relative to the assets in the banking system, adding to costs and reducing operational efficiencies. Although measures are being taken to address profitability concerns, more progress needs to be made in reducing overbanking in the countries with the biggest challenges," the Fund said.
The Washington-based institution noted that in Denmark, the Netherlands and Spain, institutions reduced their branches significantly. Such steps could represent savings of about $23 billion overall, the Fund estimated.
Another key problem among European banks is the high level of non-performing loans. In his field, the IMF said that Portugal and Italy have done very little to address this issue.
"The lack of progress on resolving nonperforming loans also reflects weak earnings and insufficient generation of capital and provisioning buffers," the IMF noted.
As the U.K. prepares to leave the European Union, there could be risks to European banks although by spreading financial institutions over a wider geographic area could help with stability.
"The challenges stemming from Brexit could undermine financial stability in ways that are difficult to estimate or predict at this juncture. However, it is also important to note that financial stability benefits could arise from a less concentrated banking system throughout Europe," the Fund noted.
With U.K-based banks planning to move some operations to European soil, the IMF pointed out that this will raise uncertainty over their internal risk models.
"Because uncertainty and operating costs will likely increase during the transition period, many banks may opt to exit or scale back the primary dealer business, leading to costlier and less efficient markets until new players enter," the IMF said.