The underappreciated strength of European banks

After more than a decade contending with the aftereffects of the Global Financial Crisis (GFC), European bank stocks have reemerged as one of the notable bright spots across the region’s equity markets in recent years. In 2024 and 2025, the STOXX^® Europe 600 Banks Index returned an impressive 35% and 77%, respectively, outperforming the broader STOXX^® Europe 600 Index by more than 105 percentage points over that span.¹

Importantly, this followed a long stretch of relative underperformance as tougher banking regulations and ultra-low interest rates weighed on profitability and loan growth. But while a low starting point and recognition of deeply depressed valuations – and subsequent multiple expansion – may explain some of the rally, improved fundamentals have been an underappreciated aspect of the story, in our view.

Indeed, the rally over the last two years has been underpinned by earnings growth, as shown in the chart below. And while the Iran conflict injected a fresh dose of macro-driven volatility, valuations across the sector remain modest, and we believe the case for further rerating is firmly intact.

Emerging from a 15-year post-GFC deleveraging cycle

In Europe, banks have spent more than a decade improving the size and quality of their capital reserves, as evidenced by a steady rise in Common Equity Tier 1 (CET1) levels and capital ratios (Exhibit 2). While this has supported banks’ ability to weather exogenous shocks, it has also constrained lending, resulting in a period of muted – and at times, negative – loan growth. This, in turn, weighed on economic growth across the region, as banks provide the majority of financing to the corporate sector.

More recently, there has been growing debate about whether the pendulum may have swung too far toward over-regulation. To date, progress toward deregulation has been limited, but discussions are underway around proposals to free up capital, support lending, and improve the competitiveness of European banks.

At the same time, risk controls and cost-cutting measures honed during the days of negative rates have vastly improved many firms’ operating efficiency. Loan books have also been significantly de-risked, with the non-performing loans ratio for significant institutions falling to roughly 2% in recent European Central Bank (ECB) data, down from more than 7% a decade ago.²

The upshot is that European banks have emerged from the prolonged deleveraging cycle as a healthier, more profitable sector, with higher interest rates providing an additional tailwind to earnings.

A more constructive operating environment

Consequently, the region’s banks have been achieving their highest profitability of the post-GFC era, as measured by return-on-equity (ROE) levels. After bottoming in the mid-single-digits range in the aftermath of the pandemic, European banks have closed the gap with their U.S. peers and, in some cases, moved ahead for the first time in years.

Valuations suggest room for further rerating

Despite this improved fundamental picture, European bank stocks continue to trade at a meaningful discount to U.S. banks and the broader European equity market. Although valuations have risen from deeply depressed levels, they have only recently returned to their long-term average.

• As of this writing, the STOXX Europe 600 Banks Index has a forward price-to-earnings (P/E) ratio of 10.1, only slightly above its long-term average of 9.5 and still well below peaks seen during the 2010s, when the sector was more fundamentally challenged.
• By comparison, the KBW Bank Index, representative of U.S. bank stocks, trades at 12.8 times forward earnings, while the P/E for the broader STOXX Europe 600 Index sits at 15.0.³

Meanwhile, European banks have been returning capital to shareholders at a healthy clip in the form of dividends and share buybacks, with the dividend yield on the STOXX Europe 600 Banks Index north of 5%, more than double that of comparable U.S. benchmarks.⁴

All of this would argue in favor of room for further multiple expansion, in our view. While some discounting to U.S. peers may be warranted, we believe the persistently wide valuation gap also reflects anchoring bias – a tendency among investors to reference past underperformance when making investment decisions.

Longer-term structural shifts and potential implications

Beyond the improved earnings trajectory and still-attractive valuations, a combination of structural shifts and secular drivers is reshaping the investment landscape for European banks and could further support the case for additional upside.

• Pro-domestic growth initiatives: As global realignment pushes Europe to focus more intently on domestic growth, competitiveness, and supply-chain resilience, banks are likely to play a key role in providing capital to the real economy – a potential tailwind for loan growth.
• AI-driven efficiency gains: While Europe’s participation in the AI secular theme is often overlooked, banks stand out as an industry particularly well positioned to benefit from automation and productivity improvements, with potential for structurally lower costs that are not yet fully reflected in expectations.
• Bank mergers / consolidation: Consolidation across the sector has historically been concentrated within national markets, but there are early indications that focus is beginning to shift toward cross‑border opportunities. If regulatory barriers ease over time, this could help reduce fragmentation and support greater scale, efficiency, and competitiveness with global peers.

Navigating an uncertain macro environment

While recent geopolitical turmoil has strengthened the case for European nations to boost defense spending – a potential tailwind that could support lending growth – the Iran conflict and resultant energy shock have cast a pall over the economic outlook for the region. The dual threat of higher inflation and potential demand destruction poses a risk for net energy-importing countries and bears close monitoring.

The ECB responded on June 11 with its first rate increase since 2023, and markets are pricing in expectations for at least one additional rate hike this year, as of this writing. For now, the combination of modestly higher rates and still-resilient, albeit less-robust, economic growth aligns with the sort of environment in which banks typically thrive. That said, even with the recent Iran ceasefire extension, questions remain about how fully the Strait of Hormuz will reopen and the extent to which any lingering supply disruption could weigh on Europe and the broader global economy.

This uncertain backdrop makes selectivity all the more critical. While we believe the case for further valuation rerating remains compelling, it is unlikely to be uniform across the European banking sector. In our view, deep fundamental research and bottom-up stock selection are essential to identifying institutions with strong capital positions, diversified earnings streams, and exposure to attractive markets supported by longer-term secular tailwinds.

IMPORTANT INFORMATION

Actively managed investment portfolios are subject to the risk that the investment strategies and research process employed may fail to produce the intended results. Accordingly, a portfolio may underperform its benchmark index or other investment products with similar investment objectives.

Diversification neither assures a profit nor eliminates the risk of experiencing investment losses.

Equity securities are subject to risks including market risk. Returns will fluctuate in response to issuer, political and economic developments.

Financials industries can be significantly affected by extensive government regulation, subject to relatively rapid change due to increasingly blurred distinctions between service segments, and significantly affected by availability and cost of capital funds, changes in interest rates, the rate of corporate and consumer debt defaults, and price competition.

Foreign securities are subject to additional risks including currency fluctuations, political and economic uncertainty, increased volatility, lower liquidity and differing financial and information reporting standards, all of which are magnified in emerging markets.