HSBC Holdings PLC (LSE:HSBA) and NatWest Group PLC (LSE:NWG) were among top picks as Citi said the European banking rally has "further to run" going into 2026, with attractive valuations, improving income trends, and strong capital return yields.
Analysts said they see further upside to consensus earnings forecasts as net interest income (NII) recovers and non-NII growth continues.
Citi forecasts a 7.5% capital return yield across the sector, supported by around a 75% payout ratio and improving earnings visibility.
Sector-wide NII is expected to return to growth in 2026, led by banks with structural hedge benefits and strong volume growth.
While Citi sees limited downside risk, it notes that “a sharp slowdown in economic growth and/or a flattening yield curve would be negative for banks,” though this is not its base-case prediction.
Best performers
UK domestic names, notably NatWest, are seen as outperformers. The broker is 5% or more above 2027 consensus earnings for HSBC and NatWest, among others.
Non-interest income is also expected to rise by 4% in 2026, with HSBC and Standard Chartered PLC (LSE:STAN) highlighted for exposure to Asian wealth growth, while Lloyds Banking Group PLC (LSE:LLOY) is among the other UK names expected to benefit from broader non-NII trends.
Valuations across the sector remain undemanding, according to Citi, with the sector trading on 1.6x price-to-tangible book for a return on tangible equity of around 16%, which gives an implied cost of equity of roughly 11% versus the long-run average nearer 12%.
"Although valuation is no longer quite as attractive, it does not look expensive either after considering growth prospects. Furthermore it still screens as cheap relative to other sectors."
Wholesale banks still have the highest implied CoEs, including Barclays PLC (LSE:BARC), HSBC, BNP Paribas and SocGen.
Stablecoin potential?
Citi also devoted a section to the potential adoption of stablecoins.
While concerns about stablecoin disruption have been raised in relation to bank business models, Citi views the risks as overstated. Though stablecoins are often positioned as faster and cheaper alternatives for cross-border payments, Citi countered this.
"Even in the near term, any speed advantage of stablecoins may not matter as much once you factor in the friction of on/off
ramps between on-chain money and fiat rails."
Cost differences may also narrow over time, too.
"As stablecoin issuers face bank-like supervision, with increased obligations around compliance, reporting, and reserve management, cost structures could gradually converge with traditional banking," the analysts said.
Future differentiation is seen as relying more on programmability and integration than on narrow cost or speed benefits, with stablecoins potentially gaining traction among smaller merchants and in underserved markets.