European Banks Show Resilience, But Fragmentation Remains a Challenge

The European Central Bank has reported significant improvements in the profitability and resilience of European banks since the pandemic. The average price-to-book ratio of European banks is now close to 1.5, narrowing the valuation gap with US banks.

The ECB attributes this improvement to a combination of factors, including better asset quality, lower cost-to-income ratios, and accelerating mergers. However, the bank notes that fragmentation along national lines remains a major constraint to long-term competitiveness.

According to the ECB, around 80% of European banks' loans are granted to domestic households and firms, while less than 2% of deposits are held in another country. This limits their ability to build pan-European business models and scale up, putting them at a disadvantage in mobilizing large investments for digitalization and innovation.

The ECB emphasizes the need for a time-bound roadmap towards completing the Single Market, including synchronised progress on the banking union and implementation of a European deposit insurance scheme. Deepening capital market integration is also essential to provide banks with greater opportunities to develop market-based financing and diversify their business.