It may surprise some that European financial sector equities have outperformed the hot tech stocks, posting returns more than 30% above the Nasdaq over the last five years. The sector’s strength was highly visible in 2024, when it led the market with a 26.6% gain – nearly 3x the broader market’s return (+9.3%). This momentum accelerated in 2025, when European financials became the best-performing European equity sector, growing 47.7% and significantly outperforming the broader European market (+20.2%). Entering 2026, we remain positive on European financials and are bullish on European banks.

Steady earnings growth underpins sector resilience

European banks’ earnings enjoyed a post-pandemic rebound in 2021, while rising interest rates provided a significant tailwind in 2022 and 2023. However, interest rates turned into a headwind in 2024 and 2025 as the ECB cut its policy rates from 4.0% to 2.0%. Despite this shift, European banks are estimated to have delivered strong earnings growth of 11.2% in 2024, with further growth of 9.6% and 7.2% we expect to see in 2025 and 2026, respectively. This resilience demonstrates the effective management of deposit franchises by banks, which helped them maintain strong interest margins. Modest lending volume growth also provided support. Crucially, banks successfully grew their fee and commission income from their payments, cards, asset management and wholesale banking businesses.

The sustained profitability has been an important driver of the sector’s performance, supporting higher dividends, increased share buybacks and a valuation re-rating for European banks. Looking ahead, the rate-cut headwind is likely to fade, as we expect a pause in ECB rate cuts for the rest of 2026. However, fiscal stimulus plans in Europe could increase the likelihood of rate hikes, potentially providing a renewed earnings tailwind for banks.

Valuations remain attractive

Steady post-pandemic earnings growth highlights the European banking sector’s resilience through both rate-hiking and rate-cutting cycles. This resilience has sparked a significant valuation re-rating of European banks. The consensus 12-month forward P/E ratio rose from 7.3x at year-end 2024 to 10.4x at year-end 2025 and currently stands at 10.6x. However, on a relative basis, the sector still trades at a 32% discount to the broader European market, compared with a 20-year average discount of 26%. Dividend yields for banks also remain attractive at around 4.8%, supported by ongoing share buyback programmes.

We expect banks’ valuation re-rating to continue as the discount to the broader market narrows, driven by continued earnings growth momentum.

Balance sheet strength drives opportunity

Regulatory restrictions implemented following the 2008 global financial crisis (GFC) have left European banks with far less leveraged balance sheets, materially reducing risk compared to the pre-GFC era. Credit losses have remained low in recent years, with benign asset quality. Potential ECB rate cuts should further ease any credit stress. Banks have also maintained strong capital buffers, supported by prudent leverage and years of consistent earnings growth.

Navigating heightened macro risks

The start of 2026 has been marked by elevated global geopolitical risks. Following tensions in Venezuela and Iran, the Greenland issue quickly escalated, causing friction in US-Europe relations, although it has since faded into the background. However, market participants should not expect a period of calm to persist, given US President Trump’s track record. A severe escalation in US-Europe tensions, including threatened or actual higher tariffs, could weaken Europe’s economic growth. Meanwhile, the Russia-Ukraine conflict remains ongoing, with little clarity on when it might end.

Conversely, the macro environment could see a lift from fiscal stimulus led by Germany, particularly in infrastructure and defence spending. Monetary policy has also loosened, with the ECB halving policy rates.

Balancing the risks and reward, we believe European banks present an attractive opportunity at the moment. We expect continued upside for the sector in 2026, on the back of a proven track record of solid management and execution.