Europe’s most boring sector is piping hot. Bank stocks are outpacing the S&P500 for the fifth straight year, defying recession fears and fading rate tailwinds. Banking analysts at Schroders and JPMorgan still see room for more gains.
While much of the market’s attention fixates on U.S. tech valuations and tariff headlines, Europe’s stocklisted banks are posting double-digit earnings growth, boosting payouts, and steadily re-rating from post-crisis lows. Investors say the rally hasn’t been driven by hope or hype, but by profitability.
Justin Bisseker, banking analyst at Schroders, believes there’s still more room to run. “Banks continue to deliver earnings upgrades, something that is quite rare in today’s times,” he told Investment Officer. Bisseker points to strong net interest margins, low unemployment, and continued credit stability as key supports for the sector. “They are not overly impacted by the ongoing noise around tariffs, and long rates remain elevated,” he said.
No return to negative rates foreseen
Even after the ECB cut rates by more than 150 basis points this year, interest rates remain well above the levels seen during the previous decade. Markets no longer expect a return to zero or negative rates, and long-end yields have held firm. That’s allowed banks to preserve earnings power despite monetary easing.
Another tailwind for earnings is the slow repricing of legacy fixed-rate assets. Many banks still hold long-duration mortgages and bonds issued during the ultra-low-rate years. “Some banks have a material continued margin tailwind behind them as these interest-earning assets reprice,” Bisseker said.
Valuations remain appealing. Pan-European banks are trading at less than 8 times their projected 2027 earnings. That’s well below the 10 times seen in Asia (excluding Japan) and 11 times for U.S. and Canadian banks. “Europe is now re-regulated, likely to sustain interest rates above 2 percent, and its growth outlook is improving,” said Bisseker. “At this point, the discount just doesn’t make sense.”
Compared to their own history, European banks still look undervalued. Before the global financial crisis, they typically traded at 10 to 12 times forward earnings. A move back to 10 times would mean roughly 25 percent upside from here, plus dividend yields of around 5 percent, Bisseker explains. “Operating conditions and the macro backdrop are much stronger than they’ve been for most of the past two decades,” he said.
Banks remain highly leveraged
Still, he acknowledges the sector’s sensitivity to shocks. Banks remain highly leveraged, and a sharp economic downturn that pushes rates back toward zero could trigger renewed underperformance. “The largest risk is a very material economic slowdown combined with a collapse in interest rates,” he said. “That would see banks underperform sharply. But the probability of such an outcome feels low at present.”
Analysts at JPMorgan take a similar view. According to Simon Poncet and Alicia Chung from the firm’s International Equities Group, the recent outperformance of European banks is grounded in fundamentals. While U.S. investors chased high-growth tech stocks in 2023 and 2024, European banks were quietly beating the local market, driven by earnings, not multiple expansion.
They note that investor confidence returned only gradually. “It took the uncertainty surrounding President Trump’s economic policy to encourage investors to return to the sector in force,” they wrote. As the return on equity of European banks converged with that of U.S. peers, the long-standing valuation gap started to close. That shift has now triggered a sector-wide re-rating.
Nearing fair value
Still, Poncet and Chung believe the sector is nearing fair value. “The recent re-rating has changed the dynamics for European banks,” they said. “Nevertheless, the banks offer a healthy yield, while there are several upside risks that could provide further support to share prices.”
One of the clearest is the potential for large-scale fiscal expansion. The European Commission has signaled that nearly 1 trillion euro will be needed to fund defence upgrades and infrastructure spending in response to Trump’s renewed “America First” agenda. If enacted, that could directly benefit banks through increased lending, capital markets activity, and investment flows. “These commitments would be positive for Europe’s banks,” the analysts said.
Southern Europe well positioned
Southern European banks are particularly well positioned. Recent results from the European Banking Authority’s 2025 stress test showed that banks in Italy and Spain experienced the lowest capital depletion under the adverse scenario. They also delivered the largest performance improvement compared to the 2023 test, thanks to stronger balance sheets, higher starting profitability, and exposure to interest rate-sensitive assets.
“The results highlight the strong fundamentals southern European banks have after two years of robust profitability,” said María Jesús Parra, Vice President at S&P Global Ratings.
Despite these tailwinds, risks remain. JPMorgan cautions that European banks are indirectly exposed to tariff-related volatility, even if they’re not directly targeted. A significant slowdown in European growth, combined with imported deflation from diverted Chinese exports, could weigh on earnings and dividends. Still, forward curves suggest the rate environment will remain supportive. “A return to the prolonged ultra-low rates of the 2010s is not expected,” the analysts said.