Imagine wrapping up a year where your industry delivers its best performance in almost three decades. That’s exactly what happened for European banks in 2025. Stocks soared, profits smashed expectations, and suddenly everyone is talking about the sector again. But as the calendar flips to 2026, a single question looms large: what do you do with all that extra cash sitting on the balance sheet?
It’s not every day that banks find themselves in this position. For years, the narrative was about cleanup, regulation, and survival. Now, it feels like the script has flipped entirely. And honestly, it’s refreshing to see.
A Banner Year That Caught Everyone’s Attention
The numbers tell a compelling story on their own. The benchmark index tracking major European banks jumped close to 60% over the course of 2025—the strongest annual run since the late 1990s. Third-quarter earnings came in strong across the board, with several big names beating forecasts handily. Some institutions even watched their market value more than double in just twelve months.
What drove this turnaround? A combination of factors aligned nicely. Higher interest rates earlier in the cycle boosted net interest margins, while cost discipline and digital transformation kept expenses in check. Loan demand picked up, deposits grew steadily, and fee-based businesses started contributing more meaningfully. In short, the fundamentals clicked.
I’ve followed financials for years, and rarely have I seen such broad-based strength in the European banking space. It almost feels like the sector finally shook off the post-crisis hangover.
Excess Capital: Blessing or Decision Headache?
Today, virtually every major European lender sits on significant excess capital. Regulators are happy, stress tests are passed with room to spare, and management teams have options—real options—for the first time in a long while.
The easy route is sticking with what has worked recently: share buybacks and generous dividends. These moves carry low execution risk and deliver immediate value to shareholders. Many banks leaned heavily on them in 2025, and investors loved the direct cash return.
But here’s where things get interesting. With profitability running at multi-year highs, banks can aim higher. Organic growth opportunities are improving—loan volumes are rising again, and fee income looks promising. Yet the real conversation in boardrooms right now centers on something the sector has largely avoided for a decade: mergers and acquisitions.
European banks are so profitable right now, you can do more than just return capital.
– Head of European financials research at a major investment bank
That quote captures the mood perfectly. Confidence is returning. Investors are supportive. And crucially, the deals being announced lately tend to be earnings-accretive from day one—meaning even the acquiring bank’s share price often rises on the news.
Why M&A Could Define 2026
After years of deleveraging and regulatory scrutiny, consolidation is back on the menu. The logic is straightforward: combine balance sheets, cut overlapping costs, cross-sell products, and diversify revenue streams. Done right, these transactions create stronger, more resilient institutions.
Expect most activity to stay domestic rather than cross-border. “Bolt-on” deals—smaller acquisitions that fit neatly into existing operations—offer lower execution risk and higher synergies. Certain markets, particularly Italy and the UK, look ripe for this type of consolidation.
One area likely to see fierce competition is specialty businesses like wealth management, asset management, and insurance distribution—the so-called product factories. These units generate stable, high-margin fee income, which is increasingly valuable as interest rates stabilize.
- Domestic deals dominate the pipeline
- Focus on wealth and asset management targets
- Emphasis on earnings-accretive transactions
- Lower execution risk with bolt-on acquisitions
Cross-border mergers remain trickier. Political sensitivities, differing regulatory regimes, and weaker cost synergies often weigh on the economics. For now, at least, the path of least resistance points inward.
Net Interest Income: From Headwind to Tailwind?
Central bank rate cuts created some pressure on net interest income during 2025. Margins compressed modestly as funding costs caught up with asset yields. Yet the decline was manageable, and now the environment appears to be stabilizing.
With major central banks largely on hold, margins should find a floor. More importantly, volume growth is accelerating again. Companies and consumers are borrowing more, deposits continue to flow in, and that underlying momentum can offset the rate headwind.
In my view, this volume rebound might be the most under-appreciated driver heading into 2026. It’s the classic banking playbook returning: lend prudently, gather stable deposits, and let the flywheel turn.
Fee Income: The Quiet Growth Engine
Another positive trend is the gradual shift toward capital-market activities among European households and companies. After decades of favoring bank deposits, investors are allocating more to equities, funds, and structured products. That behavioral change translates directly into higher fee and commission income for banks.
Wealth management divisions, payment businesses, and investment banking units all stand to benefit. It’s a healthy, structural tailwind that should persist even in a lower-rate world.
Europeans have grown more accustomed to investing in capital markets—a very healthy driver for fee income growth.
Perhaps the most encouraging part? This isn’t reliant on aggressive risk-taking. It’s simply banks capturing a larger share of wallet as clients become more financially sophisticated.
An Attractive Diversification Play for Investors
Step back and consider the broader market context. U.S. equities—particularly technology—have dominated global portfolios for years. Valuations there are stretched, concentration risks are elevated, and many investors are actively seeking alternatives.
European banks offer a compelling counterpoint. The sector still trades on single-digit price-to-earnings multiples, delivers robust dividend yields, and benefits from cyclical recovery themes. Add in repeated positive earnings revisions throughout 2025, and the re-rating makes sense.
- Low valuation relative to growth prospects
- High dividend yield with payout sustainability
- Cyclical upside in a stabilizing economy
- Natural hedge against U.S. tech concentration
Senior strategists at several large houses now describe European financials as a “consensus trade”—meaning most people agree it’s attractive. That label can sometimes signal overcrowding, but the underlying fundamentals still look solid. A steeper yield curve and modest global growth would provide a supportive backdrop.
Personally, I find the diversification argument persuasive. If you’re overweight U.S. mega-cap tech, owning a basket of well-capitalized European banks feels like common-sense balance.
Risks Worth Watching
No outlook is complete without acknowledging potential pitfalls. Geopolitical tensions could disrupt economic recovery. Regulatory changes—especially around capital requirements or climate risk—remain wild cards. And while M&A excitement is rising, poorly executed deals can destroy value quickly.
Credit quality also deserves monitoring. So far, loan losses have stayed remarkably low, but any sharp downturn would test provisions. That said, starting from a position of excess capital provides a meaningful buffer.
In short, risks exist—but they appear manageable compared to the opportunity set.
Looking Ahead: Reasons for Optimism
As we head into 2026, the European banking sector stands at an inflection point. Strong balance sheets, improving growth drivers, and strategic options create a rare confluence of tailwinds. Whether management teams lean toward buybacks, dividends, or transformative M&A, shareholders should benefit.
For investors, the message is clear: this isn’t your father’s European banking sector anymore. The turnaround story has legs, valuations remain reasonable, and the macro setup looks cooperative.
Maybe the biggest question isn’t what banks will do with their excess capital—it’s how much higher the sector can run once the market fully prices in the next chapter.
All in all, 2025 reminded us that European banks can still deliver outsized returns. If 2026 brings even half the excitement, it will be another year worth watching closely.
Here’s to a prosperous new year—for banks and for those invested alongside them.
