European bank results show little impact from Middle East conflict

European bank results for the first quarter of 2026 have revealed a strong start to the year, allaying some of the concern that the prolonged conflict in the Middle East might impact bank fundamentals to some extent.

Starting with performance, the average return on equity (RoE) for the Euro Stoxx Banks index ticked up again to 12.7% in Q1 2026, the highest this common measure of bank profitability has been since 2007, continuing a steady upward trend (see Exhibit 1).

This latest rise in profitability was due to a combination of factors and comes despite a slight rise in loan loss provisions (banks setting aside capital for potential deterioration in asset performance) in Q1. Revenue momentum has been supported by stronger net interest income (NII), with structural hedges continuing to provide support for numerous European and the large UK banks, despite the lower rate environment. Fee and commission income has also remained resilient, helped by growth in assets under management across many European banks.  

In addition, banks are continuing to benefit from their cost efficiency programmes of previous years. Some European banks, including leading UK institutions, have also upgraded their 2026 NII guidance, reflecting market expectations of higher rates post-conflict. This should support core margins and help offset slower loan origination in a highly competitive lending market, though the broader impact from the conflict to European banks will clearly depend on how any resolution plays out.  

Rise in provisions is a cautionary measure

The conflict has already resulted in banks increasing loan loss provisions, which were roughly 20% higher year-on-year in Q1 2026. However, this increase is from a very low base, and higher provisions do not necessarily mean higher defaults will materialise. The increase in provisions was mainly driven by updates to banks’ accounting models and forward-looking macroeconomic scenarios, as opposed to actual defaults taking place.  

It is also worth noting that most European banks have only limited direct exposure to the Middle East (0.5% of total asset exposures across the sector, according to the European Banking Authority) with only a few exceptions. As a result, we think they are unlikely to face a material direct impact from the conflict. That said, second-round effects from movements in key macro indicators, such as higher inflation and slower growth, could certainly impact the sector. This may include some banks moving towards the higher end of their cost of risk guidance (loan loss provisions as a proportion of total loan balance) by year-end.  

In this instance we believe the increase in provisions for banks is a precautionary measure rather than a response to stressed asset quality measures or an increase in actual defaults. This is not to say these will not come, but so far, the impact has been very limited. Were these more negative scenarios to materialise, banks might decide that they already have sufficient provisions, which means their financials might not be as severely impacted as the news flow might suggest.

Balance sheets remain resilient, supported by new issuance

European bank balance sheets also remain healthy, with some growth in deposit volumes and broadly stable lending origination, though there is some dispersion across segments. There was a small decline in deposit volumes for some banks, but this is a seasonal trend typically seen in the first quarter of the year. European banks’ primary market issuance has also been strong, with the €18.8bn of Additional Tier 1 (AT1) bonds issued year-to-date only slightly down on the same period in 2025 (see Exhibit 2).

This appetite for issuance likely reflects a generally attractive refinancing window, with AT1 spreads having quickly retraced their March widening to move back to their pre-Iran lows.

UK banks remain well provisioned following the FCA rule change

One key trend in the quarter was UK banks’ provisioning in relation to the motor finance scandal, after the Financial Conduct Authority cut the projected cost of its compensation scheme by some £2bn in March. This has led to only minor adjustments to the provisions the banks have already booked against the issue. 

Overall, Q1 2026 results provide a useful anchor point for assessing whether European banks have been affected by the Middle East conflict and whether their full-year guidance is still achievable. Results have been strong, with no clear signs of stress across the sector. We would also point out that bank margins would benefit from a scenario of higher monetary policy rates.  

Provided any rate hikes that do emerge from the European Central Bank or Bank of England are not accompanied by a recession that increases defaults and provisions dramatically (which we see as very unlikely), banks’ full-year 2026 results might be even better than otherwise.