European banks: A core pillar of Europe’s investment case

• European banks maintained strong net income growth in 1Q 2025, defying the effects of rate cuts. Slower growth in net interest income was offset by robust fee income expansion, which is emerging as a key earnings driver going forward.

• Loan volumes are recovering, led by strong growth in housing loans as interest rates decline. With policy stimulus measures expected to take effect, business loan demand is also likely to rebound, providing additional support to NII.

• European banks are flushed with capital, enabling them to sustain dividend payouts and share buybacks. At the same time, they are exploring domestic and cross-border consolidation opportunities to enhance operational efficiency, broaden client coverage, and expand into new business segments.

• We project a target price of GBX 4,297 for the Amundi STOXX Europe 600 Banks UCITS ETF Acc (LSE:CB5) by the end of 2027, based on a fair price-to-book (PB) multiple of 1.0X. This implies an upside potential of 7% by the end of 2027. With resilient earnings and superior dividend yields of 5-6% over the next three years, European banks are an attractive income-generating segment.

Solid net income growth in first quarter

2025 is the first year in which the effects of rate normalisation are fully captured in European banks’ income. The top 10 largest European banks reported a solid net income growth of 10.9% year-on-year (YoY), driven primarily by resilient revenues. Despite modest cost increases and a sharp 13.4% rise in loan loss provisions, as banks set aside reserves in response to heightened macro uncertainty, net income still rose 10.9% YoY in 1Q 2025. This indicates that the 5.0% increase in net revenue was the primary driver of earnings growth, while operating costs rose by just 1.0%. In other words, the improvement in profitability was driven largely by topline expansion rather than cost-cutting.

Chart 1: European banks reported solid net income growth, while net interest income varies

To break down net revenue: UK banks have benefitted from the Bank of England’s more gradual rate-cutting cycle (a total of 100bps from the peak of 5.25%), resulting in better-than-expected net interest income (NII). British banks such as Barclays and NatWest Group stand out with strong double-digit NII growth of 17.3% and 17.0%, respectively.

For non-UK European banks, amid the ECB’s more aggressive rate cuts (200bps from a peak of 4%), net interest margins have declined from their peak. However, the contraction remains manageable, supported by structural interest rate hedges and a high proportion of fixed-rate assets accumulated during the previous tightening cycle. These factors have reduced sensitivity to recent rate cuts. Additionally, slower repricing of retail deposits has helped preserve interest margins. The pickup in loan demand also helped offset the decline in interest margins and contributed to stabilising NII growth.

Over the past five years, European banks have made improvements in efficiency, as evident by the improvement in cost-income ratio (49.9% from 51.7% last year) and rise in operating margin (41.7% from 40.9% last year). However, the scope for further cost savings is narrowing, with cost growth already contained at 1.0% in the first quarter this year. Going forward, earnings growth will likely depend more on revenue drivers, especially through fee income and other catalysts, rather than further cost reduction.

Fee income poised to be the next revenue driver

Fee income currently accounts for around 33% of total revenue among the top ten banks, growing at 7.8% YoY, significantly outpacing the 1.0% YoY growth in NII in the first quarter. During the rate hike cycle of 2022–2023, when risk-free rates reached 4-5%, NII experienced mid-to-high double-digit growth, benefiting from higher net interest margins. In contrast, fee income growth was relatively muted during that period. Looking ahead, as rates decline and NII growth slows, this upward momentum in fee income is likely to continue for the following reasons.

Chart 2: NII growth remains resilient, while fee income shows strong momentum

Chart 3: Fee income accounts for about 33% of net revenue

Trading fees remain a major contributor to European banks’ fee income. Amid persistent macro uncertainty, heightened market volatility has triggered more frequent portfolio adjustments, equity trading volumes surged, as shown by a surge of 17% YoY growth in March across European stock exchanges. Meanwhile, fixed income trading is also strong, with corporate clients increasingly hedging currency and interest rate risks. These trends suggest that trading-related revenues will continue to offer resilient support to overall fee income in the coming quarters.

Fee income from wealth and asset management has benefited from positive market performance and increased investor appetite for higher-return products. This is particularly notable as risk-free alternatives have become less attractive amid falling interest rates. As a result, average assets under management (AUM) across the top ten European banks rose by 15.3% YoY in 1Q 2025, building on the already strong 10.3% YoY growth in 4Q 2024.

Loan demand is picking up, further driven by fiscal stimulus package

Banks are showing a recovery in total loan growth, with the top 10 banks' median loan growth reaching 3.96%. Breaking down the drivers, housing loan demand has risen significantly and continues to accelerate — growing 39.3% YoY in 4Q 2024 and 41.6% in 1Q 2025 — primarily driven by lower interest rates, and to a lesser extent, an improved housing market outlook and rising consumer confidence. Consumer credit growth remains modest at 2.4%, but forward-looking indicators point to steadily improving demand.

Chart 4: Loan growth is accelerating for the top ten banks

Chart 5: Mortgage demand has accelerated; business loan growth is likely to be driven by the stimulus package

In contrast, business loan growth continues to lag, with expansion slowing to low single digits. This reflects the impact of tariffs and firms' cautious stance on operations and long-term investment. However, if Europe’s fiscal stimulus plans are effectively implemented, they could reverse the stagnation seen in 2023–2024 and unlock business loan growth across sectors. Planned investments in Europe’s strategic autonomy have exceeded EUR 1.6 trillion, including:

• EUR 800 billion under the Rearm Europe plan by 2030,
• EUR 500 billion from Germany’s infrastructure fund by 2035,
• More than EUR 300 billion via Repower EU by 2027, and
• More than EUR 43 billion through the European Chips Act by 2030.

Combined with lower borrowing costs, this would support a rebound in loan demand and contribute to banks’ NII recovery. Early signs of a manufacturing turnaround — evident in a bottoming out in manufacturing PMI and factory orders despite heightened macro uncertainty — further reinforce this potential upcycle.

M&A activity is a new growth driver

The CET-1 ratio remained well above regulatory requirements, with an average buffer of 301 basis points across major European banks. UniCredit, BBVA, and HSBC stand out with particularly high buffers (ranging from 350 to 580bps), reflecting strong excess capital. To avoid return-on-equity (RoE) dilution, many banks are increasingly redeploying capital through dividends and share buybacks. While attractive to shareholders, these strategies offer limited long-term growth potential. In contrast, mergers and acquisitions (M&A) provide a path to sustain earnings momentum via revenue and cost synergies.

As the rate cycle turns downward, banks are demonstrating a growing appetite for acquisitions, using external growth to offset pressure on lending income. M&A allows banks to strengthen their operating leverage, expand geographic footprint, and enhance service offerings. Meanwhile, the return to privatisation of several large banking groups following government divestments, such as NatWest and Commerzbank, has given these institutions more strategic autonomy to pursue growth opportunities.

This shift is already evident in deal flow, with European banking M&A volume rising 22.2% year-over-year in the first quarter of 2025. Despite ongoing consolidation, the sector remains fragmented. Only six European banks are currently among the world’s top 25, up from just two at the start of the year, highlighting significant room for further scale-building.

Chart 6: European bank M&A activity rebounded after 2024

BNP Paribas exemplifies this trend through its expansion into asset and wealth management, key fee-generating segments. The bank recently completed its acquisition of AXA Investment Managers, creating a EUR 1.5 trillion platform and gaining exposure to high-growth areas such as private credit, infrastructure, and real estate. BNP projects a revenue CAGR of over 5% (2024–2026) and a return on invested capital (ROIC) exceeding 20% by 2029, underscoring the strength of expected synergies.

UniCredit is also pursuing a dual-front strategy. Domestically, it is seeking to acquire Banco BPM (~EUR 10bn), which would consolidate its leadership in Italy and enhance efficiency and client reach. Regionally, UniCredit has also explored expansion into Germany via Commerzbank.

Ongoing capital return commitments

Dividends remain a key driver of total returns for European banking stocks, providing an additional boost to overall investor returns. Thanks to excess capital accumulated during the previous rate hike cycle, European banks have executed record-high capital return programs, through both dividends and share buybacks. This capital strength provides a solid foundation for ongoing shareholder payouts.

From 2020 to 2024, total dividends paid by European banks have steadily increased from EUR 7.6 billion to EUR 82.2 billion, while share repurchases have grown from EUR 4.5 billion to EUR 39.7 billion. This clear upward trajectory demonstrates management’s strong commitment to shareholder returns and supports the outlook for continued high dividend yields.

Looking ahead, high dividend distributions are expected to continue, underpinned by robust CET-1 buffers that remain well above regulatory thresholds. According to consensus estimates, the top 10 European banks are expected to maintain an average dividend payout ratio of around 46% over the next three years, with forecasted dividend yields of 5.2%, 5.7%, and 6.3% for 2025, 2026, and 2027 respectively.

Dividend return visibility is underpinned by clear, quantifiable payout frameworks. For instance, UniCredit has committed to distributing at least 50% of its net profit in cash dividends from 2025 to 2027, while BNP Paribas has transitioned to a semi-annual dividend structure, offering predictable income based on a fixed 50% earnings payout. These forward policies, backed by strong capital buffers, suggest that current dividend yields can sustain.

Table 1: Consensus projected dividend distributions

In 1Q 2025, BBVA paid a final dividend of EUR 0.41 per share for 2024, bringing total 2024 distributions (including cash dividends and share buybacks) to EUR 5.0 billion, representing 50% of attributable profit. Despite the takeover bid to acquire Banco Sabadell, BBVA has explicitly stated its commitment to maintaining an attractive distribution policy, targeting a payout of 40-50% of annual profits. To protect its ability to continue paying dividends, BBVA carefully structured the deal by using a share-based offer rather than an all-cash transaction and agreed to a phased integration timeline to spread out the associated costs.

Another example is BNP Paribas’s acquisition of AXA Investment Managers, which closed in mid-2025. BNP Paribas explicitly confirmed that its dividend and share buyback policy would remain unchanged, and the ECB had already approved the 2025 buyback program. This consistency signals to investors that banks can maintain attractive shareholder returns even when engaging acquisitions.

Banking strength reinforces the case for European equities

Valuations have climbed and are now broadly in line with fair value, with the STOXX 600 European Banks Index trading at approximately 1.0X of price-to-book (PB) valuation — matching its estimated fair PB. Looking ahead, while room for further multiple expansion may be limited, earnings growth remains the primary support for equity performance. We see earnings supported by three catalysts to compensate for slowing NII growth, including growth in fee income, particularly from trading and wealth management activities; loan growth, supported by fiscal stimulus measures across the European region; reviving M&A activity amongst banks, which boosts investor returns through enhanced revenue synergies.

We project a target price of GBX 4,297 for the STOXX 600 Banks Index by end-2027, based on a fair PB multiple of 1.0x. This implies an upside potential of 7.07%. Investors who wish to gain exposure to European banks sector may consider the Multi Units Luxembourg - Amundi STOXX Europe 600 Banks UCITS ETF Acc.

With resilient earnings and superior dividend yields of 5-6% over the next three years, European banks are an attractive income-generating segment. For dividend-focused investors, the sector offers both yield and capital upside.

Table 2: Projections for SX7P Index

Table 3: ETF’s top 10 portfolio holdings

More broadly, the strength of European banks enhances the investment case for the region as a whole. As US exceptionalism is under pressure, the geopolitical need for diversification has become increasingly urgent. While Europe has long been criticised for its excessive bureaucracy, Trump’s assault on the rule of law in the US has, by contrast, made European institutions appear more stable and reliable – their checks and balances are, at the very least, not in question.

As the US retreats from global trade, Europe is positioned to assume a more prominent role in shaping a new liberal trading order. Trump's tariff policies have already prompted the EU to diversify its trade relationships, rekindling long-stalled negotiations with partners in Asia and beyond.

Meanwhile, the region is benefitting from a wave of fiscal stimulus, most notably Germany’s historic shift away from its strict debt constraints — including the removal of its debt cap on defence spending and the launch of large-scale infrastructure funds. This is further supported by the EU’s broader commitment to industrial reshoring.

Combined with still-attractive valuations relative to the US, we believe European equities — anchored by the resilience and dividend strength of the banking sector — offer a compelling risk-reward proposition for global investors. Investors who still wish to gain diversified exposure to European equities may consider the Eastspring Investments Unit Trusts - Pan European SGD. Alternatively, a passive approach can be taken with Vanguard FTSE Europe ETF.

Declaration:

For specific disclosure, at the time of publication of this report, IFPL (via its connected and associated entities) and the analyst who produced this report hold a NIL position in the abovementioned securities.