European banks carry profit momentum into 2026

With most European banks having now reported their full-year 2025 results, we see the sector carrying solid momentum into 2026.

Profitability generally remains robust and well diversified, despite normalising net interest income due to rate cuts, while capital ratios continue to have a healthy buffer to minimum requirements and asset quality remains resilient despite pockets of stress in some sectors. This has supported the continued outperformance of European bank capital instruments, with the CoCo index up 1.75% this year through February 23 versus 0.99% for the European high yield index.

The robust earnings are reflected in the price-to-book multiple of the Euro Stoxx Banks index (SX7E), which stood at 1.38x as of December 2025. For context, that metric only broke above 1x in early 2025, having spent more than 15 years below it, an important shift for the sector since it indicates some level of market confidence that banks can generate returns over their cost of equity.

The improvement in profitability has not only driven higher equity valuations for European banks, it has also materially strengthened their capacity to absorb loan loss provisions through earnings rather than by depleting capital buffers. From a credit perspective, improved internal capital generation directly lowers “tail risk” from potential loan losses and reinforces balance sheet resilience, which has helped banks’ credit spreads to tighten over recent months.

Beyond the headline numbers, there are a few trends worth noting for fixed income investors.

First, in terms of profitability, at 12.3% the return on equity (RoE) of the SX7E index in 2025 was broadly in line with 2024. This reflects more subdued net interest income in a rate cut environment, offset to some degree by higher loan origination volumes and banks locking in higher fixed yields with structural hedges. Notably, bottom-line results have been increasingly supported by stronger non-interest fee income, as banks continue to diversify their revenue mix thereby reducing reliance on core margin generation and enhancing earnings durability. On the cost side, trends were mixed. While overall operating expenses have increased year-on-year, large banks have delivered a meaningful improvement in efficiency ratios, whereas smaller banks have seen ratios weaken as they ramp up technology spending having historically lagged the larger banks in digital investments. Still, overall the sector’s profitability is expected to improve this year with a consensus RoE of 13.1% for 2026, supported by efficiency gains from recent investments, continued structural hedge gains and more diversified income streams.

Second, measures of asset quality main robust, with non-performing loan (NPL) ratios continuing to sit near historic lows, thanks to the disciplined underwriting standards and prudent risk management frameworks embedded across European banks. Banks’ cost of risk (measured by annualised provisions for losses as a percentage of the loan book) is below the cycle average, driven by a combination of modest growth, falling rates and inflation. Benign labour market conditions across Europe have also been a key driver of limited NPL generation to date, though there were signs of weakening employment data in late 2025 notably in the UK and France. While the current trajectory does not suggest a sharp deterioration, a prolonged rise in unemployment in these economies could begin to feed through into higher NPL volumes. Banks remain well diversified across sectoral exposures, though pockets of stress are evident in commercial real estate (CRE) and in auto lending amid post-tariff pressures. However, CRE exposures have not translated into a broader rise in NPLs for all but a handful of lenders.

Third, capitalisation across European banks remains a core credit strength, with Common Equity Tier 1 (CET1) ratios averaging around 16% in 2025 providing strong buffers above regulatory minimum requirements. This healthy position has been primarily driven by robust internal capital generation, which has comfortably offset shareholder distributions through dividends and buybacks. Basel 3.1, is expected to be fully implemented in the UK by the end of this year, having taken effect in Europe last month. One key strand of Basel 3.1 is making Risk Weighted Assets (RWAs) calculations more conservative on certain categories of lending such as CRE to better capture credit and market risk, thereby making it more expensive from a capital point of view for banks to have exposure to the sector. Accordingly, the impact on capital will vary by bank; those with higher CRE concentrations should see greater RWA inflation and some pressure on capital ratios, while the impact on more diversified institutions should be broadly credit neutral.

Finally, consolidation in the European banking sector has accelerated, driven by competitive pressures and opportunistic acquisitions supported by strong equity valuations among acquiring banks. Challenger banks have been absorbed, while bigger banks pursue transactions not only to enhance scale, but to continue diversifying away from the pure banking model into insurance and asset or wealth management. We expect further M&A to remain targeted and value-accretive, focused on diversification and efficiency gains. From a credit standpoint, deals are supportive for bondholders where they strengthen earnings resilience without materially diluting capital.

Given these trends, it is no surprise that bank debt has traded well in recent months and has continued to do so despite record supply in AT1s at the start of the year. With a robust fundamental picture and a positive technical for bank debt driven by investor demand, we maintain our positive view on the sector.