While downside risks abound, the operating environment for European banks is generally positive heading into 2026, says Morningstar DBRS Inc.
In a new report, the rating agency said that it expects profitability to be stable, or to improve a bit, for the sector in the coming year.
This year, profits have eased from recent highs, amid declining net interest margins, but DBRS expects those margins to stabilize in 2026, with the European Central Bank holding interest rates steady.
“Combined with positive loan growth, this is likely to drive moderate growth in [net interest income],” it said.
At the same time, the banks’ non-interest income — fees and capital markets-related income — which was the “sweet spot” for the banks in 2025, are expected to continue growing in the coming year.
However, growth is forecast at a slower pace compared with this year, when a spike in market volatility drove a sharp increase in trading revenues, and rising markets supported other fee-based revenues.
“While we expect volatility to persist in 2026, it is likely to moderate compared with 2025,” the report said.
Additionally, lower interest rates and high equity valuations, “are likely to support debt and equity origination as well as investment banks’ advisory businesses,” it said.
Sustained economic growth should also support higher fees from loan origination, transaction processing and cards, it noted.
Banks’ operating expenses have been “well contained,” the report said — adding that it expects this to continue into 2026.
“Wage inflation has declined, but it is still the main cost driver. This has been offset by efficiency gains, mostly driven by increasing digitalization of processes. We believe that digitalization has more room to grow, especially with the implementation of AI, which could help contain costs in 2026 and beyond,” it said.
Despite the positive operating environment, there are an array of risks to the outlook, it noted.
“We generally view the environment as supportive of bank earnings. However, there could be significant downside risks related to the impact from global trade friction, geopolitical uncertainties and high asset valuations,” cautioned Sonja Förster, senior vice-president of European financial institution ratings at Morningstar DBRS, in the report.
In particular, the report said that, “the biggest threat to revenues would come from a significant correction in asset valuations.”
Nevertheless, the sector’s capitalization remains strong, the report noted.
“Looking ahead, we expect a gradual decline in capital ratios because of asset growth, regulatory changes, shareholder returns and increased merger and acquisition activity,” it said.
“With strong balance sheets and improved profitability and risk profiles, European banks are generally better positioned to carry out acquisitions,” the report said. “The rationale for the transactions is the search for greater scale and/or more diversification, either geographically or in terms of financial products, in particular fee-income generating businesses such as asset management and insurance.”
Overall, DBRS said that it expects additional consolidation activity in 2026, but that large, cross-border transactions will, “remain the exception, given the … still-fragmented regulatory landscape in Europe.”