European banks bullish despite tariff uncertainty

European banks are coming to the end of the Q1 2025 reporting season, and on the surface there are multiple headwinds to contend with. Interest rates – generally a significant factor in banks’ earning potential – have come down from peak levels, and economic uncertainty has been heightened by somewhat inconsistent trade rhetoric from the US administration. Under the hood, however, European banks very much appear to be powering through, with many reporting results that are ahead of consensus expectations (about 10% ahead at the sector level) and slightly better than in Q1 2024.

The European banks equity index (SX7E) was only around 2% off its early year high as of Friday. Additional Tier 1 (AT1) bonds have also recovered strongly, in many cases trading above or around the levels seen at the end of March. More importantly, despite the tariff uncertainty, European banks are confidently affirming their full-year guidance – in some cases they have even raised some of their projected numbers. This has been a key difference between financials and corporates in the latest earnings season, and we see a number of factors worth highlighting.

First, the impact of tariffs in the services sector (of which banks are a major component) is indirect through a weaker economic picture, rather than direct as is the case with auto manufacturers. Some of the indirect consequences we will be keeping an eye on for the remainder of the year include volatility in financial markets putting the brakes on some parts of the investment banking business (M&A, primary debt and equity market issuance, for example), lower rates negatively impacting deposit margins, rising corporate bankruptcies in Germany and finally, the narrative of delayed rate cuts and a potential economic slowdown in the US which may continue to put pressure on unsecured consumer lending and commercial real estate exposures for lenders in that region.

But despite all those well-documented headwinds, European banks have been reporting largely better than expected results in the first quarter of this year and guiding to strong outlooks for the remainder of 2025.

In investment banking, the heightened volatility that has dampened primary capital market activity has boosted trading flows in secondary markets, leading to stronger results from European banks’ Equities and FICC (Fixed Income, Currencies and Commodities) divisions. In retail and commercial banking, despite rates trending lower in Europe, banks are seeing fewer clients shifting towards higher interest term deposits than was the case in late 2023 and early 2024. Current account balances that pay 0% have begun growing again, prompting some banks to hike their net interest margin guidance for the year, as many see ongoing benefit from structural hedging activities.

Corporate lending has remained subdued, mirroring the growth trends in the European economy, but mortgage lending has picked up in some regions, possibly due to lower rates versus even a year ago. This is quite important for all banks, but even more so in specific regions. French banks, for example, tend to hold a large stock of longer fixed rate loans and other assets; higher new lending volumes allow them to roll over a bigger proportion of their balance sheets into higher rates faster, therefore improving overall profitability of the local retail operations.

Economic headwinds from tariffs may be difficult to quantify at this stage, but it is significant that European banks have not felt the need to downgrade their projections as a result. As we mentioned earlier, some have raised parts of their guidance, and across the sector there has been no material change in the outlook for bad loan provisions. This is in stark contrast to early 2020 when many banks simply suspended results guidance due to the onset of Covid-19 or had to put through large provisions, and it is also in stark contrast to the current situation in the corporate sector, where many have decided to scrap their full-year outlooks in response to tariffs. To be clear, we do not think European banks are insulated from the broader macroeconomic trends, but as the operating environment is evolving, banks have shown they are also adapting better to the new realities. For example, increasing usage of significant risk transfer transactions to reduce credit risk when spreads are attractive, or in the case of some French banks, pursuing M&A transactions to reduce their reliance on long dated fixed rate assets by moving towards fee-based or shorter dated lending leasing businesses.

Overall, we welcome another quarter of solid reporting from European banks. We take comfort in the fact that executives see bullish full-year targets as attainable at this stage despite the known headwinds, especially since the same cannot be said about every firm in the non-financial sector. European banks cannot be fully insulated from broader macroeconomic trends, but in our view this latest earnings season is further evidence of the resilience of the sector despite significant changes to rates, regulation, and business environment over the last few years.