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The UK banking sector has delivered strong price returns to investors over the last five years, averaging 218% compared with a 50% gain for the blue-chip FTSE 100 index.
On a total return basis, including dividends, the sector has chalked up 279%, making it the second-best performing sector in the FTSE 350 index after the aerospace and defence sector.
It is worth pointing out that from a longer-term perspective the share prices of the domestically focussed banks Lloyds and NatWest still languish well below their highs in 2007.
That is not true for internationally diversified UK banks like HSBC and Standard Chartered, whose share prices have since eclipsed their 2007 highs, while Barclays sits somewhere in the middle, remaining around 25% below its 2007 highs.
What explains the strong performance?
Strong returns over the last five years represents a renaissance for banks after a decade in the doghouse following the financial crisis in 2008 which required banks to rebuild their beaten-up balance sheets.
The last five years have also witnessed a radical change in the interest rate environment which was driven by the Bank of England hiking interest rates from virtually zero before the pandemic to 5.25% in 2023.
This pushed up interest rates across the yield curve which has provided a positive tailwind for the sector. The yield curve represents the cost of borrowing money over different lengths of time, from a few months to 30 years.
The yield curve normally slopes upward which means borrowing costs get progressively more expensive. For example, two-year interest rates are roughly 3.6% while 10-year rates are 4.5%.
This interest rate spread allows banks to make a positive ‘net interest margin’ on the difference between the rate of interest they charge on long-term loans and the interest they pay on short-term deposits to attract funding.
As interest rates normalised post 2020 towards a typical upward sloping curve, net interest margins ‘fattened’ significantly, resulting in record-breaking profits for sector in 2024.
Banks have also benefited from the fact they typically pass on higher interest rates to savers with a lag while increasing lending rates immediately.
How sustainable is the boost from higher rates?
UK banks actively manage interest rate risk and typically use five-year rolling hedges to smooth their income.
Hedges put on during the period of ultra-low interest rates in 2020 matured during 2024 and 2025 which means banks have an opportunity to put on new hedges at today’s higher rates of between 4% and 5%.
Analysts believe this could give banks an income boost by protecting net interest margins through the next few years even if the Bank of England cuts short-term interest rates.
That suggests the fundamental profit drivers may remain resilient, but what about the share prices?
NatWest and Barclays are top 10 positions in the Temple Bar investment trust which is managed by fund managers Ian Lance and Nick Purves at value-driven investment firm Redwheel.
Commenting on the outlook for banks, Lance says: ‘It should be self-evident that the returns witnessed in recent years are unlikely to be repeated in the next few years as the re-rating component of the return is unlikely to be repeated. That said, the valuations of the banks still look reasonable at a time that fundamentals remain strong.’
Are balance sheets healthy?
After many years of rebuilding capital buffers following the financial crisis, capital ratios across the sector are now healthy. Tier one capital adequacy ratios average 17% across the sector.
This is a measure of a bank’s core financial strength which compares equity capital to total risk-weighted assets. In other words, how much capital does a bank have to absorb future losses from its loan book.
UK banks must meet the Basel 6% minimum tier one capital level and the Bank of England’s higher system-wide 13% benchmark, which considers extra buffers for tougher economic times.
The Bank of England has estimated that UK banks have tier one capital resources equivalent to about 2% of their risk-weighted assets, giving them adequate headroom.
This healthy position has allowed the sector to shift from hording cash to aggressively returning capital to investors via share buybacks and dividends. The six largest banks announced or distributed £36 billion of dividends and share buybacks in 2024 according to S&P Global Ratings.
Healthy dividend yields and aggressive share buybacks has attracted the attention of value investors and those seeking core income stocks.
What does the competitive landscape in the UK look like?
The ‘Big Four’ banks comprising Lloyds, NatWest, Barclays, and HSBC dominate, controlling around 80% of UK household deposits with the rest held by building societies and mutual banks.
The largest banks have seen their market share shrink over the five years as digital challenger banks like Monzo and Revolut have become more popular.
Over 2024 and 2025 traditional banks lost an estimated £100 billion in deposits as consumers moved money to these challengers, which were offering higher short-term savings rates.
Lloyds is the clear market leader in mortgages with roughly a 19% market share, followed by Nationwide Building Society with 17% and NatWest with 11%.
The building societies and mutual firms hold just under a third of the UK mortgage market.
Challenger banks and specialist lenders collectively account for roughly 60% of gross lending to small businesses, exceeding the combined share of traditional banks.
Lloyds is the largest credit card issuer in the UK, holding nearly 22% of outstanding credit balances in 2024. Alongside Barclays and HSBC, these three banks account for around half the UK credit card market.
What are the banks’ strategies?
The two broad themes which stand out across the sector in recent times include an efficiency push through digitalisation and artificial intelligence and increasing diversification into higher margin business segments.
As the most domestically focused bank Lloyds fortunes are heavily tied to the performance of the UK economy.
The company is undergoing a strategic transformation under CEO Charlie Nunn which has seen a move into capital-light business segments such as wealth management, pensions and insurance.
For example, in 2025 the bank fully acquired Schroders’ 49.9% stake in their joint venture, Schroders Personal Wealth in exchange for a 19.1% stake in Cazenove Capital.
The business was rebranded as ‘Lloyds Wealth’ and accelerates the push into the ‘mass affluent’ sector which serves clients with more than £75,00 in income or investable assets.
Lloyds is closing many of its physical branches to lower operating costs while investing in AI and data as it pursues a ‘digital first’ strategy.
Management believes these initiatives will generate an additional £1.5 billion of revenue by the end of 2026.
The company has adopted a progressive dividend policy which has seen the dividend increase by an average of 16% a year over the last three years. Total shareholder distributions have totalled £14.4 billion since 2021.
Fellow domestic player NatWest is following a similar strategy of reducing costs amid a digital transformation with around 80% of retail and commercial customers using the bank’s digital channels.
NatWest recently entered a five-year partnership Amazon’s web services company AWS and professional services group Accenture to drive productivity gains.
It was also the first UK bank to partner with ChatGPT owner OpenAI.
NatWest’s growth strategy includes strategic acquisitions and a key milestone in 2025 was the integration of Sainsbury’s Bank which added roughly one million accounts.
After nearly 17-years of government ownership following the financial crisis, NatWest finally returned to full private ownership in May 2025. The bank is targeting a return on tangible equity of greater than 18% and a cost-to-income ratio of around 47.8%.
For context, return on tangible equity is a profitability metric which measures how much profit a bank generates relative to its tangible equity capital.
Tangible equity is calculated as shareholders’ equity minus intangible assets like goodwill and other non-physical assets.
For example, if a bank has £10 billion in tangible equity and it generates £1.5 billion in net profit, its return on tangible equity is 15%. This would be considered a healthy return for the banking sector.
The cost-to-income ratio measures the efficiently of a bank’s operations. It is calculated by dividing operating expenses by operating income, expressed as a percentage.
Operating expenses include items like staff salaries and administrative costs. Well-run banks typically aim to achieve cost-to-income ratios below 50%.
Reducing the importance of investment banking
Barclays is in the middle of a multi-year transformation aimed at simplifying the business.
This involves reducing the relative size of its investment banking division and increasing the size of higher returning businesses like Barclays UK corporate bank.
The company is targeting £2 billion of efficiency savings by the end of 2026 and exiting non-core international markets to focus on the UK and US. Barclays bolstered its UK unsecured and credit card business after integrating Tesco’s bank in late 2024.
Barclays has committed to returning at least £10 billion to shareholders in 2026 and uniquely, moved to more frequent quarterly share buybacks. The bank is targeting a return on tangible equity of 12% in 2026.
HSBC and Standard Chartered are the least UK-exposed banks with market-leading franchises across Asia and the Middle East.
Under new CEO Georges Elhedery HSBC has undergone a strategic overhaul to simplify its spawling organisational structure and focus on increasing market share where it believes it has competitive advantages.
The business now operates four divisions including Hong Kong, the UK, global corporate and institutional wholesale and international wealth management.
A key development for HSBC is its bid to buy the remaining 37% of Hang Seng bank it does not already own in a $13.6 billion deal aimed at consolidating its leading position in the Hong Kong market.
Share buybacks have been put on hold until the bank absorbs the cost of buying Hang Seng.
How do I buy passive exposure to banks?
Not all investors will be comfortable choosing individual banks to invest in, and while there are no UK-specific bank sector ETFs, there are European products which provide exposure to UK banking stocks.
The largest pan-European banks ETF is the Amundi STOXX 600 Banks UCITS ETF which has £1.8 billion of assets and annual charges of 0.3%. It is the only ETF to track the STOXX 600 Banks index.
The ETF seeks to replicate the performance of the underlying index using derivatives. Dividends are accumulated and reinvested. HSBC is the fund’s largest holding at 12.8% while Lloyds, Barclays and NatWest feature in the top 10 holdings.
Martin Gamble: Shares and Markets Writer
Martin Gamble is Shares and Markets writer at AJ Bell. He was previously the Education Editor of Shares Magazine. He has been with the business since 2019.
Martin graduated from the University of Kent in...
