Banking and Insurance Stocks: More Substance Than Valuations Suggest

• Kjell Morten
  Portfolio Manager
  DNB Asset Management

Many investors still view financial stocks through the lens of the global financial crisis. Banks are seen as cyclical, prone to regulation, and risky; insurers as cumbersome; and payment service providers are often classified more as part of the technology sector. This view is increasingly outdated. Today’s financial sector is no longer the financial sector of 2008. The sector has become significantly more resilient. Since the financial crisis, banks and insurers have built up capital, improved their liquidity, strengthened risk management, and adapted their business models to meet stricter regulatory requirements. Banks now hold higher-quality capital and are subject to stress tests, liquidity ratios, leverage limits, and more proactive risk provisioning. Insurers operate under more risk-sensitive solvency rules, with stronger corporate governance, greater transparency, and stricter oversight. As a result, the sector is entering the current economic cycle with a significantly greater ability to absorb shocks than it had before 2008. Banks and insurers are less indebted, more liquid, better regulated, and more transparent. In a downturn, therefore, they are likely to act as stabilizers rather than amplifiers. However, robustness should not be confused with immunity.

This is precisely where the investment opportunity lies. Despite the sector’s strong performance in recent years, many investors’ expectations remain subdued. Valuations remain attractive, and solid capital positions support high returns on equity. In our view, the sector’s fundamentals have improved more sustainably than current market expectations reflect. Investors therefore have room to reassess the long-term value creation potential of financial stocks.

European banks remain undervalued

This is particularly evident among European banks. A certain valuation discount relative to U.S. institutions remains justified. Europe’s economic growth is structurally slower, its banking and capital markets are more fragmented, political and regulatory risks are higher, and its capital market infrastructure is less developed. However, the extent and persistence of this discount appear excessive. The markets underestimate how sustainably the profitability of many European banks has improved, how strong their capital base is today, and the discipline with which excess capital is now managed and distributed.

The best European institutions should therefore no longer be viewed as ailing legacy banks, but rather as mature, well-capitalized companies capable of increasing returns on capital and creating attractive shareholder value over time. This is all the more true given that Europe faces enormous investment challenges. The Draghi Report estimates the additional investment needed at around 750 to 800 billion euros per year to close innovation gaps, improve competitiveness in the energy sector, decarbonize industry, and strengthen security and resilience. A fragmented financial system will struggle to mobilize capital on this scale. Europe therefore needs stronger banks, deeper capital markets, and a functioning savings and investment union.

Payment service providers are the sector’s technology winners

In addition to traditional banks, other segments of the financial sector also offer structural opportunities. Payment networks such as Visa and Mastercard have long since ceased to be merely traditional financial stocks. They are increasingly evolving into technology-driven infrastructure companies. Their value no longer lies solely in card acceptance, but in secure, tokenized, data-rich, and globally interoperable payment functions—for cards, digital wallets, e-commerce, B2B payments, stablecoins, and new digital business models. As a result, these companies exhibit characteristics similar to those of technology companies: network effects, high scalability, strong data advantages, and recurring transaction activity. At the same time, they remain deeply embedded in the regulated financial system and are exposed to political and regulatory risks. It is precisely this combination that makes them interesting: they combine structural growth with a central role in the global financial infrastructure.

AI Can Significantly Improve Productivity and Efficiency

Artificial intelligence will also transform the financial sector. In the short term, the greatest impacts are likely to be felt in productivity and operational efficiency. Financial firms are process- and data-intensive and have high cost bases in technology, compliance, customer service, credit screening, and back-office operations. AI can automate routine tasks, improve document processing, accelerate software development, and make employees more productive. Particularly concrete use cases are emerging in risk management and fraud prevention.

Both established institutions and fintechs can benefit from this. Large providers have trusted customer relationships, extensive data sets, compliance capabilities, and the ability to spread technology and regulatory costs across a broad customer base. Fintechs, on the other hand, can develop new solutions without legacy burdens and gain market share where AI enables better user experiences or more efficient processes.

However, it is crucial to note that investing in AI is not the same as having an AI advantage. The winners will be those companies that combine data, scale, regulatory expertise, and implementation discipline.

The risks remain manageable, but real

Nevertheless, the risks remain real. The most important traditional risk is credit quality. A weaker macroeconomic environment could lead to higher credit defaults in parts of the sector. However, the starting point is better than in previous cycles: Credit growth has been more disciplined overall, capital adequacy is more robust, lending standards have improved, and accounting requirements mandate earlier recognition of potential losses.

The second major risk is operational resilience, particularly cybersecurity. Financial firms are becoming increasingly digitized and interconnected. This also increases the potential consequences of cyberattacks, fraud, and operational disruptions. It is therefore crucial for investors to focus not only on valuation and returns on capital, but also on balance sheet strength, risk culture, technology investments, and the quality of management.

Investors should reassess the potential for value creation

Over the next twelve months, the market is likely to underestimate, above all, the sustainability of value creation in the financial sector. Many financial firms are better capitalized, more disciplined, and more focused on returns than in previous cycles. They have the balance sheet strength to transition from a restructuring phase to a phase of active value creation—whether through organic growth, dividends, share buybacks, or acquisitions.

For investors, therefore, financial companies that combine sustainable competitive advantages, disciplined capital allocation, and robust long-term value creation profiles are particularly attractive. These include well-capitalized banks, insurers with pricing power, technology-like payment service providers, as well as investment banks and banks with strong investment banking divisions.

Today, the financial sector is better capitalized, more resilient, more technologically advanced, and strategically more important for financing growth and transformation than it was before the financial crisis. This is precisely why investors should no longer underestimate financial stocks.