European banks are on track for their strongest year since 1997, with the Stoxx 600 Banks Index surging nearly 60% since the start of the year. The region's lenders enjoyed a strong earnings season, with HSBC and UBS among those posting profit beats in the third quarter, while select names — including Commerzbank and Societe Generale — have seen valuations more than double over the past 12 months. It all caps what Benjamin Goy, head of European financials research at Deutsche Bank , called a "stellar year" for the sector. "European banks are well capitalized. Most of them, or all of them, are in significant excess capital territory," Goy told CNBC. .SX7P YTD mountain Stoxx 600 Europe Banks Index. But as lenders look to maintain their momentum into 2026, the big question now weighing over management teams is what to do with this excess capital. While organic growth opportunities are improving, banks are now "so profitable, you can do more," Goy said. Share buybacks and capital dividends are frequently used and provide low execution risk. But focus is expected to tilt toward another option — inorganic growth, namely M & A activity — next year, allowing banks to diversify revenue streams and bolster growth. "That's something the sector had been missing for almost a decade," Goy said. "There's confidence coming back among management teams. Investors are increasingly supportive, and the deals announced are actually typically earnings-accretive, and that's why even the acquirers' stock price tends to go up. We would expect more of this activity to happen." Speaking to CNBC's " Europe Early Edition " on Dec. 9, Goy said that both Italy and the UK were consolidation hotspots, with activity dominated by domestic "bolt-on" deals where "execution risk is lower, and synergies are strong … [and where it's] easier to announce profitable deals." Several of Deutsche's top picks for the year — including Monte dei Paschi , Erste Group , Bank of Ireland and Barclays — are expected to be involved in such activity. Competition for so-called "product factories" — such as wealth and asset management and insurance — is likely to prove particularly fierce within the M & A sphere, though cross-border activity remains challenging, owing to greater execution risk, typically lower synergies, and political scrutiny, he added. CBK-DE YTD mountain Commerzbank AG. Elsewhere, investment strategists also pointed to strong loan and deposit growth, which is expected to further underpin the sector's resilience in 2026. RBC BlueBay Asset Management said European banks have benefitted from a growing desire among global investors to diversify their equity exposure away from U.S. tech this year, with strong cyclical sectors — including financials — seeing repeated earnings upgrades, resulting in re-ratings. Turnaround story Sharon Bell, senior European equity strategist at Goldman Sachs, said that European banks were now "quite a consensus trade" — but added that a steep yield curve and further economic growth next year globally would still offer a "good environment for banks." "It's also a sector still on a single-digit P/E. We talk about where to diversify away from an expensive concentrated market like the U.S. — European banks couldn't be a better diversifier from that perspective," Bell told CNBC's " Squawk Box Europe " on Dec. 11. Deutsche Bank's Goy said increased net interest income and fee income as key revenue drivers that will help power banks' growth into 2026. He said that Europeans have grown more accustomed to investing in capital markets— "a very healthy driver for fee income growth" — which will help offset the lower rate environment as the European Central Bank holds steady on rates. "Net interest income remains the most important revenue driver for this sector," Goy said. "ECB and other central bank rate cuts [brought] somewhat of a headwind; there was a modest decline in 2025 in net interest income. But now with most central banks being on hold and margins stabilizing, this volume growth is coming through again ... That is the big turnaround."
