Has the tide turned for Europe's banks?

Instead a war, an energy crisis, recession and runaway inflation conspired to undermine the long-anticipated benefits from the first meaningful interest rate rises in a decade. As a result, and despite bumper profits across the region, investors have stayed away as pessimism about rising defaults and potential windfall taxes outweighed optimism from higher dividends and buybacks.

"There is still fundamental nervousness about the sector," said Magdalena Stoklosa, an analyst at Morgan Stanley. "There's little faith that banks can rewire, despite the fact that balance sheets are solid, liquid, and very well capitalised, and profitability has improved."

Morgan Stanley estimated that European lenders' pre-provision profit will rise 16 per cent in 2022 and another 8 per cent next year. They are forecast to return at least €100bn via dividends and stock buybacks from now until the end of next year, with another €31bn of excess capital to return more or absorb recessionary loan losses.

Long awaited central bank rate rises have juiced earnings through dramatic increases in net interest income (NII), as the amount charged for loans has risen faster than the rate paid out on deposits.

However, that windfall has caused little change in long-term sentiment. The benchmark index of European banks has fallen 5.8 per cent this year and the comparable UK index rose only 4.5 per cent - both outperformed the broader stock market but on a five-year basis they remain down close to 30 per cent.

As was true back in 2018 - seen as a postcrisis nadir for the sector - only two of the 20 largest British, French, German, Italian, Spanish, Scandinavian and Swiss banks trade above book value: wealth manager UBS and Sweden's Nordea.

But some suggest that the extraordinarily turbulent environment of the past three years should be seen as a stress test rather than a cause for alarm. "If you had told people we are going to get a war in Ukraine, recession, the LDI pensions blow up and late-cycle episodes like the collapse of FTX and European banks would still outperform the market, that is pretty resilient performance after what was thrown at them," said Stuart Graham, co-founder of Autonomous Research.

"2022 has taught us that we need to be humble," he added. "It is a 'show me' story to prove banks are cheap. Many investors want to see it before they believe."

Bank executives from Barclays to UBS have been on charm offensives in the US to sell that story, promising higher payouts and strict cost controls. UniCredit's Andrea Orcel has committed to return €16bn of capital to shareholders by 2024 as he seeks to boost the share price and win himself a pay rise.

But the legacy of underperformance since the 2008 crisis has been hard to shake. In May,

Capital Group - one of the few active investors backing European banks - dumped €7bn of stock after concluding the damage of a recession would outweigh the benefit of rate rises.

"In the last 13 years there has been focus on remediation, restructuring and implementation of regulation. Capital and investment have gone to those rather than innovating and driving growth . . . [this] has left an enduring discount on banks," said Lloyds chief executive Charlie Nunn.

"People look at us as a bellwether for the UK economy . . . If confidence is rebuilt we will automatically deliver a much stronger share price than we see today," he added. "But there is a nervousness in investors about how financial services will be able to respond."