Sector Outlook
Executive Summary
Global financials enter the second half of 20 26 in a peculiar spot for the market: the central banks we thought would be cutting are teasing additional hikes, but bank fundamentals have never been stronger. Credit is coming in, capital is near all-time highs, and valuations remain below those of the broader market despite two years of solid earnings growth. We are bullish on the sector over a 6-12 month time frame with the exception that if the Fed decides to accelerate the pace of rate hikes or if long-end bond yields suddenly rise, this thesis could be squeezed rapidly. Why we like banks: Banks are essentially being paid to hold capital at ~4%, loan losses are trending down from their pandemic high, and the market is still discounting financials relative to this reality. Money-center banks, highly capitalized Canadian banks, and payments platforms are best positioned to benefit from this gap in price vs. fundamentals.
Macro Backdrop
The rate environment financials find themselves in today is certainly not what most prognosticators were expecting one year ago. While the Fed has kept its policy rate in a range of 3.50%-3.75% since December, hotter-than-expected economic data last month (162,000 jobs added in August and unemployment remained at 4.1%) has lifted CME FedWatch odds of a 25bp hike at the September 16 meeting to around 60%, and UBS is now calling for two hikes this year, at September and December. This comes amidst overt political pressure from the White House on Fed leadership to cut rates, resulting in a very interesting disconnect between market pricing and political rhetoric. The Bank of Canada has left its overnight rate unchanged at 2.25% for seven straight meetings, but Governor Tiff Macklem sounded hawkish in September remarks attributing recent inflation at 3% (well above its 2% target) to tariff escalation with the US and oil prices lifting due to tensions in the Middle East. The ECB hiked its deposit rate to 2.25% in June from 2.00%, while the BoE has kept Bank Rate at 3.75% but with one dissenting voter who wants to hike to 4.00%.
All told, this is a mixed but net positive environment for bank margins. US bank NIMs dipped across the industry to 3.22% in Q1 20 26 from 3.30% in the prior quarter as asset yields eased slightly, marking the first quarterly contraction since mid-20 24. Large banks are starting to see their margins expand as their large fixed rate asset bases reprice higher, however: U.S. Bancorp's taxable-equivalent NIM rose to 2.79% in Q2, up 13 basis points from a year ago, and loans grew by an average of 7.1%. TD Bank NIM rose to 2.88%, up 5 bps, and net interest income grew 7% while average loans grew 5%. Truist NIM is currently at 3.02%, and management now expects full year NIM to exceed the 20 25 average given that anticipated rate cuts for 20 26 are no longer priced in by the market. Net loan growth has been running from 3% to 7% across large US banks, depending on the institution. Solid but notsuggestive of a super-heated economy.
Credit continues to be the best part of the puzzle. The credit card delinquency rate in the US fell to 2.85% in the 2nd quarter of 2026 from 2.95% in Q4 2025, and has steadily trended down from its peak in 2024. Bank of America's card delinquency rate fell to 1.26% in July from 1.37% a year ago, and net charge-offs fell to 2.13% of loans from 2.25%. Large banks are provisioning less for expected credit losses as well: Goldman Sachs cut its credit provision expenses by roughly 73% from year ago levels in Q2, due in part to pulling back lending on its credit card book. Citigroup remains an outlier as it continues to guide for a net credit loss rate on its card book of 4% to 4.5% for 2026, which would be well above pre-pandemic norms. Commercial real estate exposure at regional banks and long-duration bond yields continue to be the pieces of the market that have systemic risk priced in. Yields on the latter have recently battered UK mortgage banks as UK gilt yields surged in tandem with US Treasuries. Neither have triggered a systemic event, but both remain the tail risks that
Key Drivers
Higher-for-longer rate path uncertainty. Changing dynamics around global monetary policy have switched the conversation around earnings growth for banks from expected rate cuts to potential rate hikes at the Fed, BoC, and BoE. Higher-for-longer/still rates are generally positive for NIM in the near term (as banks’ loan books reprice faster on the margin than deposit costs), but a sustained hiking cycle is negative for loan growth (lower demand) and could reactivate deposit competition. Net: modestly positive NIM catalyst, swing loan growth risk.
Improving credit. Banks are releasing reserves as both delinquency and charge-off rates trend lower from pandemic-era highs across cards, autos, and most consumer lending segments. Lower provisioning feeds directly to pre-tax income and acts as a tailwind to earnings. Bullish, and the most consistent driver of bank earnings beats for US lenders in 2026.
Capital markets reopening. Lower provisioning requirements and rates have run in parallel with an industry-wide increase in trading, underwriting, and advisory revenues. This development disproportionately favors banks with large capital markets businesses. Banks with significant investment banking or trading revenues, as well as large capital markets units within more diversified money-center banks, should benefit. Bearish for pure-play regional banks that rely less on non-interest income.
UK/US regulatory relief. Announced in May 2026, the UK Treasury's ring-fencing reform bill will allow banks’ ring- fenced and non-ring fenced divisions to share back-office services and unlock £80 billion in new lending capacity for the UK's five largest banking groups. Bank of England expects Ring Fence Act impact on ROE to be visible from 2027, so this is more of a slow-play than a short-term trade. Bullish for UK banks, but a gradual catalyst as implementation takes until 2027.
Saudi & geopolitical pressure on Canadian banks. The Saudi government slowed bank credit growth from 5.4% to 2.2% YoY as PIF-funded projects were postponed and global interest rates climbed, Russia’s war in the Middle East continues to push up oil prices (and weigh on global growth), and could make the Bank of Canada's inflation battle even tougher. Congested oil markets are negative for GCC loan growth, while higher-for-longer in Canada could force additional BoC hikes, squeezing Canadian bank NIMs if housing sales slow (and cutting into wealth management revenues).
Regional Lens
U.S. stocks offer the widest exposure to capital markets recovery and credit normalization. U.K. names are a regulatory-catalyst story layered on top of already strong capital positions. Canada is the most conservative call: We like these banks for their exceptional capital strength, but earnings growth is likely to be capped by a hawkish central bank and housing sensitivities. Credit growth is slowing in the GCC, even as sovereign liquidity will continue to support the region's banks and Islamic finance institutions in the long-term.
Valuation and Positioning
Sentiment and valuations Credit remains cheap versus history and the market. Invesco KBW Bank ETF (KBWB) is trading at forward P/ E of 12.4 or just 61% of the S&P 500 forward P/E of 20.4. From a Zacks screen, Financials forward P/E is 11.47 versus 20.01 for the S&P 500. KBW also notes in their recent 2026 sector outlook on European banks that they are trading at 1.5x Tangible net asset value and producing ROTE near 15%, whereas in previous cycles this combination would have commanded a premium multiple given the upward sloping yield curve and rates above 2.5%. European banks are also benefiting from strong credit quality, as CET1 ratios are well above regulatory requirements, allowing banks to reward shareholders through dividends and buybacks. US banks have been raising dividends through the pandemic and have started buying back stock at high levels, as can be seen in Scotiabank which just announced a new $3 billion buyback. CET1 at 13.1% gives the bank room to continue buying back stock while growing EPS.
Bank stocks aren’t fairly valued, they look cheap given improving credit quality, solid loan growth and capital ratios near all-time highs. The biggest reason for the continued discount is investors don’t believe the current rate environment will persist given the hawkish turn at the Fed and BoC. Should rates stabilize and we avoid a harsh hiking cycle, banks could easily rerate back toward their average multiples.
Companies or Sub-Sectors to Watch
JPMorgan Chase should enjoy most of the capital markets recovery and their overall franchise allows them to weather rate volatility better than regional banks.
NatWest Group has the highest upside in the UK based on their return on tangible equity (lowest at 18.2%), smallest CET1 drawdown from the recent stress test compared to other UK banks, and direct exposure to ring-fencing reform which could free up lending capacity.
Royal Bank of Canada and Toronto-Dominion Bank have the highest capital buffers among developed market banks, leaving room to continue raising dividends should the Bank of Canada start hiking rates once again. Average sector CET1 is 13.7%.
Goldman Sachs benefits directly from the reopening of capital markets as well as improving credit costs. The bank reported credit loss provisions that were down approximately 73% year-over-year in the latest quarter.
Visa and Mastercard should continue to see growth from consumers while providing a lower risk alternative to financials. The companies earn money from transaction volume and do not carry credit risk like traditional lenders, protecting them from pressures we’re seeing from card losses at banks like Citigroup.
Key Risks
An acceleration in Fed rate hikes above the one or two currently expected would dampen loan demand and drive up deposit expenses faster than assets reprice, eliminating the NIM tailwind this thesis is built upon.
C's projected 4% to 4.5% card net credit loss rate for 2026 suggests consumers haven't completely healed from the pandemic. A reversal in labor market fortunes from today's 4.1% unemployment rate could see delinquencies trend upward again, not only for Citi but for the industry as a whole.
If long-duration yields resume their climb like they have in the UK, weighing on mortgage lenders such as OSB Group, US banks could see a double-whammy of lower mortgage origination volume and increased mark-to-market losses on their bond portfolios. Canadian and UK banks would be affected similarly.
Slowing credit growth in Saudi Arabia due to the government cooling project spending could impact other Gulf nations if oil prices slump further or if there are additional cuts to sovereign wealth fund spending in domestic banks.
Conclusion
Financials are one of the few sectors that offer improving credit fundamentals, near-record capital levels, and a valuation discount that has lagged both. There are no guarantees, however, as rate policy is more uncertain now than at any time in the last two years. Fortunately, the sector is priced for much more fear than the fundamentals warrant. We like global financials, particularly diversified US money-center banks, well capitalized Canadian banks, and UK banks that should benefit from deregulation.