Assessing the Resilience of European Banks Amid Tax Uncertainty and Political Risk in 2025

The European banking sector in 2025 presents a compelling case for investors seeking defensive opportunities in a high-uncertainty environment. Despite persistent challenges from tax policy shifts and geopolitical tensions, the sector’s fundamentals—bolstered by improved capital resilience and stable profitability—suggest strategic entry points for those willing to navigate short-term volatility.

Stress-Tested Resilience: A Foundation for Stability

The 2025 EU-wide stress test results underscore a marked improvement in the sector’s ability to withstand severe economic shocks. Banks’ capital depletion under adverse scenarios fell to 370 basis points (bps), down from 479 bps in 2023, with the average CET1 ratio dropping to 12.06% from 15.76% [1]. This improvement reflects stronger profitability, which offset €394 billion in credit losses, and better risk modeling of sectoral impacts [1]. While non-performing loans (NPLs) remain a concern, the EBA emphasized that proactive loan restructuring could mitigate future capital erosion [1].

The ECB’s upcoming 2026 stress test will explicitly incorporate geopolitical risks, such as trade wars and supply shocks, signaling a recognition of their growing influence on bank portfolios [1]. For now, the sector’s ability to absorb losses—evidenced by a 10.5% return on equity in Q1 2025—suggests a buffer against near-term uncertainties [2].

Tax Uncertainty and Divergent Impacts

The 2025 tax policy changes, including permanent adjustments to the FDII deduction rate and estate tax thresholds, have introduced economic policy uncertainty (EPU) that affects banks unevenly. Commercial and real estate banks face declining profitability due to EPU, while investment and savings banks may benefit from increased market volatility [3]. Crucially, capital adequacy ratios (CARs) act as a moderating force, with higher CARs reducing the negative impact of EPU on profitability [3]. This asymmetry creates opportunities for investors to target banks with robust capital buffers and diversified revenue streams.

Valuation Metrics: Undervalued Defensives

European banks trade at a P/E of 9.10 and a P/B of 1.18, with a dividend yield of 4.89% as of July 31, 2025 [4]. These metrics, combined with a Morningstar Europe Index price/fair value of 0.98, indicate undervaluation relative to fundamentals [2]. The Netherlands and Denmark, for instance, are undervalued by 10% and 14%, respectively, driven by strong performances from financial sector leaders [2].

Analyst ratings reinforce this narrative. While geopolitical risks and trade tensions pose headwinds, European banks are expected to maintain resilient earnings, supported by stable net interest income (NII) and controlled cost of risk [5]. The sector’s ability to outperform expectations in Q1 2025—despite a 7.4% GDP contraction in Finland under stress scenarios—highlights its structural strength [6].

Strategic Entry Points: Balancing Risk and Reward

Investors should prioritize banks with:
1. High CET1 ratios (e.g., Dutch banks, which saw a 3.9 bps decline in 2025 stress tests [6]).
2. Diversified fee income (e.g., 9% year-on-year growth in Q1 2025 [2]).
3. Geopolitical risk hedging (e.g., institutions with minimal exposure to politically volatile regions).

However, caution is warranted. Political influence on credit allocation—such as increased mortgage approvals in politically sensitive regions—can degrade asset quality and inflate loan loss provisions [7]. Similarly, tax policy shifts may disproportionately affect banks with real estate exposures under CRR 3 [1].

Conclusion

European banks in 2025 offer a rare combination of defensive qualities and undervaluation. While tax and political risks persist, the sector’s stress-tested resilience, improving profitability, and attractive valuation metrics make it a strategic opportunity for long-term investors. The key lies in selecting institutions with strong capital buffers, diversified earnings, and prudent risk management—qualities that will determine which banks thrive as the sector navigates the next phase of uncertainty.

Source:
[1] EU-wide Stress Test 2025: Results Publication [https://kpmg.com/xx/en/our-insights/ecb-office/eu-wide-stress-test-2025-results-publication.html]
[2] Q1 European banking results 2025 | EY - Global [https://www.ey.com/en_gl/insights/financial-services/emeia/how-european-banks-outperformed-in-q1-2025-despite-global-headwinds]
[3] Divergent Effects of Economic Policy Uncertainty on European Banks Profitability: Role of Capital Adequacy Ratio [https://www.researchgate.net/publication/394697681_Divergent_Effects_of_Economic_Policy_Uncertainty_on_European_Banks_Profitability_Role_of_Capital_Adequacy_Ratio]
[4] MSCI Europe Banks Index (EUR) [https://www.msci.com/www/index-factsheets/msci-europe-banks-index/0454557258]
[5] Mid-year European bank outlook: earnings expected to ... [https://scoperatings.com/ratings-and-research/research/EN/179096]
[6] European banks prove resilient under stress scenario [https://www.dnb.nl/en/sector-news/supervision-2025/q3/european-banks-prove-resilient-under-stress-scenario/]
[7] Political influence and banks: Evidence from mortgage ... [https://www.sciencedirect.com/science/article/abs/pii/S1042957322000353]