The Case for European Banking Stocks in a Shifting Fiscal and Geopolitical Landscape

The European banking sector is undergoing a transformational phase driven by regulatory clarity, fiscal stimulus, and surging defense demand. For investors, this confluence of forces presents a compelling case for strategic value creation—a rare alignment of macroeconomic tailwinds and sector-specific innovation. As the EU's 2025 stress tests underscored the sector's resilience, the regulatory environment has shifted from mere survival to proactive growth, while defense-related financing opportunities are unlocking new avenues for profitability. Here's why European banks are positioned to outperform in this evolving landscape.

Regulatory Clarity: A Foundation for Resilience and Growth

The 2025 EU-wide stress test, conducted by the European Banking Authority (EBA), revealed a sector better prepared for volatility than in recent years. Despite a simulated EUR 547 billion loss, European banks maintained a CET1 ratio of 12%, reflecting improved profitability and capital generation. This resilience is a direct result of regulatory reforms such as CRR3, which integrates ESG risks into risk frameworks and enhances transparency. The stress test results also highlight the importance of the Supervisory Review and Evaluation Process (SREP), which ensures banks' capital adequacy aligns with evolving risks.

Regulatory clarity has allowed banks to allocate capital more efficiently, reducing the burden of uncertainty that previously constrained strategic investments. For instance, the EBA's 2025 methodology now includes centralised net interest income (NII) projections and a risk-sensitive market risk approach, enabling institutions to model scenarios with greater precision. This shift from reactive compliance to proactive risk management is a catalyst for long-term value creation.

Fiscal Stimulus and Defense Demand: A New Growth Engine

The EU's fiscal stimulus measures, particularly the Security Action for Europe (SAFE) facility, are injecting EUR 150 billion into defense and security projects. This is part of a broader EUR 1.2 trillion annual spending plan to address green, digital, and defense transitions. The European Investment Bank (EIB) has tripled its defense financing to EUR 3 billion, with partnerships like its EUR 1 billion agreement with Deutsche Bank targeting SMEs in the defense supply chain. These initiatives are not just about funding—they're about reshaping the European economy to prioritize strategic autonomy.

The Readiness 2030 package, which allows Member States to temporarily exceed expenditure limits for defense, further amplifies this momentum. By 2031, defense spending is projected to require an additional EUR 320 billion annually, with the EIB and commercial banks playing a pivotal role in channeling private capital. For example, the EIB's “Pan-European Security and Defence Lending Envelope” has already catalyzed projects like Lithuania's military base construction and R&D in advanced materials.

Strategic Partnerships and Innovation in Defense Financing

European banks are leveraging their balance sheets to become enablers of strategic growth. The EIB's fast-track permitting regime for defense projects, which reduces approvals to 60 days, has spurred collaboration with institutions like BPCE and Deutsche Bank. These partnerships are not only accelerating funding but also fostering innovation in areas like AI and robotics—sectors critical to future defense capabilities.

Moreover, the EIB's TechEU program, allocating EUR 70 billion for technological leadership, underscores the sector's pivot toward innovation-driven finance. This aligns with the European Commission's Startup and Scaleup Strategy, creating a pipeline for high-growth opportunities. For banks, this means expanding beyond traditional lending to become strategic partners in defense R&D and supply chain resilience.

Stock Performance and Analyst Outlook: A Sector on the Rise

European banks have outperformed broader markets in 2025, with Banco Santander (SAN) up 13.7%, HSBC (HSBA) up 7%, and BNP Paribas (BNP) up 10.3% in May alone. Analysts are increasingly bullish: BNP Paribas, trading at 7.3x forward earnings, has the highest buy strength at 55%, with a projected EPS of €12.4 by 2027. Similarly, Commerzbank AG, boosted by UniCredit's stake-building, is forecasted to see 25.6% EPS growth in 2026.

However, the sector is not without risks. UBS Group AG, for instance, faces potential capital demands of $26 billion under Swiss reforms, while DNB Bank ASA's EPS is expected to decline by 7% in 2026. Investors must balance these idiosyncratic risks against the sector's structural tailwinds.

Investment Thesis: Balancing Risk and Reward

The European banking sector's strategic value creation is underpinned by three pillars:
1. Regulatory Tailwinds: CRR3 and ESG integration are reducing compliance costs and enabling capital-efficient growth.
2. Defense-Driven Demand: Fiscal stimulus and EIB partnerships are unlocking EUR 1.2 trillion in annual spending, with banks positioned as intermediaries.
3. Attractive Valuations: Banks like BNP Paribas and Santander trade at discounts to analyst price targets, offering margin of safety.

For investors, the key is to focus on institutions with strong ESG frameworks, diversified revenue streams, and active participation in defense financing. Avoid overleveraged peers like UBS, but consider strategic bets on underappreciated banks like Nordea, which has a 13.4% implied upside despite short-term challenges.

In a world where geopolitical tensions and fiscal stimulus are reshaping global economies, European banks are no longer just custodians of capital—they are architects of strategic value. For those who recognize this shift early, the rewards could be substantial.