LONDON Europe's banks have gone through the toughest phase of their restructuring but still face a period slimming their loan books that will be a challenge for several years, Morgan Stanley (MS.N) said.
"While we think we are probably four years through a decade-long process of bank deleveraging and restructuring, we may be over the worst and most pernicious phase," Morgan Stanley analyst Huw van Steenis said on Tuesday.
Action taken by authorities, including the European Central Bank's bond-buying plan, should allow banks to "accelerate cleaning up their balance sheets" and that will likely lead to greater differentiation among bank stocks next year, van Steenis said in a report, '2013 Outlook'.
The report said the earnings outlook for Europe's banks continued to be plagued by a weakening economic backdrop, deleveraging, low interest rates and high bad debts.
But the market may not have realised how much progress has been made by banks on reducing overseas assets, which may help some banks' earnings stabilise, U.S. investment bank Morgan Stanley said.
Euro zone banks have cut non-domestic assets by about $7 trillion, or 40 percent, in the last four years, including by $2 trillion in the past year, it said. Trading assets had halved, although Swiss bank UBS UBSN.VX had shown there was "plenty more to do".
"Our key focus in on just a handful of cheap banks with strong earnings power in their core franchises and that have reasonable odds that they can accelerate restructuring, exit non-core assets effectively and, critically, start to pay meaningful dividends," the report said.
Morgan Stanley said its top picks were Aberdeen Asset Management (ADN.L), BNP Paribas (BNPP.PA), Barclays (BARC.L), Sberbank (SBER.MM), Swedbank (SWEDa.ST) and UBS.
(Reporting by Steve Slater; Editing by David Goodman and Dan Lalor)