Banking on a Continued Recovery in European Financials

Banking on a Continued Recovery in European Financials

Second phase of growth could be underway as Eurozone credit demand improves.

By John Whelan

Key points:

• The first phase of recovery in European financials – driven by interest-rate normalisation – is complete. This potentially sets a solid floor for earnings growth for European banks.
• The second phase of recovery – a shift to lending volume growth – appears to be starting. A return to credit growth is being fuelled by signficant fiscal stimulus and an end to deleveraging across the Eurozone.
• PM Capital expects this expansion in lending volumes in the Eurozone to drive higher bank earnings, potentially justifying a re-rating of valuation multiples of European financials.

The recovery in European bank stocks is entering a pivotal second phase.

Although the initial rally was driven by the normalisation of interest rates, emerging data on credit growth¹ suggests a broader fundamental shift: a recovery in credit demand across the Eurozone.

European banks remain the cornerstone of PM Capital’s global equities strategy.² Our core holdings include major institutions such as ING Groep, Lloyds Banking Group, Bank of Ireland, AIB Group, CaixaBank and Intesa Sanpaolo.

We continue to believe these institutions remain undervalued, offering a potential opportunity for a long-term valuation re-rating.

Performance Context: From Contraction to Recovery

For more than a decade, European banks traded at significant valuation discount compared with their US and Australian peers.

In 2020 and 2021, PM Capital increased its exposure to European banks, believing the market had overreacted to recessionary risks in Europe.

Our thesis has been validated by recent performance: the MSCI Europe Banks Index (EUR) has delivered an annualised return of 42.89% over three years to 31 December 2025.³

Despite this rally, we believe the recovery in European banks may be incomplete. The recent outperformance follows a long period of stagnation, suggesting the ‘catch-up’ trade in European banks could have further to run.

The sector’s long-term underperformance is reflected in the MSCI Europe Bank Index’s annualised return of only 3.94% since 31 December 1998.⁴

European banks have underperformed the broader European equities market for more than two decades, with the MSCI Europe Index delivering an annualised return of 5.28% since 31 December 1998.⁵

 Phase One: Interest Rate Normalisation

The first leg of the recovery in European financials was driven by the end of the "negative interest rate" era.

As global inflation proved more persistent than anticipated - driven by energy costs, reshoring, and labour shortages - the European Central Bank (ECB) aggressively tightened monetary policy throughout 2022 and 2023.

This higher interest rate environment benefitted European bank Net Interest Margins (the difference between interest paid and received) and thus bank earnings.

With Eurozone rates now stabilising at a "higher-for-longer" normal rate, market confidence in sustained earnings growth for European banks has solidified, in our opinion.

Phase Two: Resurgence of Credit and Deposit Growth

As European recessionary fears subside, we could be observing the beginning of a volume-driven recovery. An expansion in credit growth is a critical catalyst to earnings growth for the sector:

• Household Lending: Annual loan growth to European households reached 3% in December 2025, the fastest pace in over two years.⁶
• Corporate Credit: Annual loan growth to non-financial businesses was 3% in December 2025, a marked improvement on the prior year.⁷
• Deposit Stability: Annual household deposit growth was 3% in December 2025.⁸ A larger, stable deposit base allows banks to fund loans more cheaply or place excess liquidity with the ECB’s deposit facility—a lower-risk path to profitability.

This credit and deposit growth is being underpinned by significant fiscal stimulus in the EU. Germany’s €500 billion infrastructure and climate investment package⁹, coupled with increased defense spending across the EU, is acting as a catalyst for industrial activity and, by extension, credit demand.

Phase Three: Valuation Gap and Structural Catalysts

Despite the 2025 rally in European financials, a valuation gap persists between European banks and their global counterparts.

Source: MSCI Europe Banks Index (EUR) Fact Sheet at 31 December 2025. Yahoo Finance for CBA data at 4 February 2026.

We believe a re-rating of European P/E multiples is justified by several structural tailwinds:

1. Regulatory Easing: After years of stringent post-pandemic oversight, the ECB is moving toward simplifying banking regulations. Reducing the "regulatory burden" could act as a modest but consistent tailwind for returns on equity for European banks.
2. Consolidation: The sector is becoming more efficient through mergers and acquisitions. Significant mergers, such as CaixaBank’s acquisition of Bankia and Intesa’s takeover of UBI Banca, have created larger, more resilient institutions with superior economies of scale.
3. Digital Transformation: The integration of Artificial Intelligence (AI) offers a unique opportunity for banks to automate high-cost manual compliance and loan processing, potentially lowering cost-to-income ratios and improving risk monitoring.

Conclusion

PM Capital’s investment in European banks is a testament to the value of patience and contrarian thinking.

Although the first phase of interest-rate normalisation is largely complete, the second phase - driven by credit expansion and operational efficiency gains - is just beginning, in our opinion.

We anticipate that the market could eventually reward these higher-quality, higher-earning banks with a larger valuation multiple.

Although geopolitical risks and macroeconomic fluctuations will inevitably cause short-term volatility, the long-term trajectory for European financials remains compelling, in our opinion.

PM Capital remains well positioned to potentially capitalise on what we believe could be a multi-year re-rating of the European financials sector.

About the author

John Whelan is co-Portfolio manager of PM Capital’s Global Companies Fund and Australian Companies Fund. More PM Capital insights are available here.