European bank shares have been knocked to two-year lows but bargain hunters are not biting yet.

The lowly valuations reflect a deeply bearish view on the European and US economies and the risk to earnings and capital raisings, investors and analysts said.

And profits may not recover to lofty pre-crisis levels anytime soon, as finance watchdogs across the globe tighten the rules after the credit crisis plunged the world into its worst economic crisis since the Great Depression.

"You might say banks were good value now, but they might still be (at that level) in five to 10 years time," said a fund manager at a top UK firm who holds several banks.

"That visibility is what investors are lacking in order to get excited about the sector because they cannot see what the upside trigger is."

Bank shares - closely linked to the health of the economy given the hit earnings take from lower income, higher bad debts and trading losses - are trading at half their historic averages, sending a grim signal on economic prospects.

The European bank index is trading at 6.7 times the next year's expected earnings, according to Thomson Reuters estimates - well up from the sector's low of 4.9 times when the financial crisis raged in 2008.

But that compares to an average multiple of 10.8 over the last decade and 12 over the past 16 years.

The reasons are that investors expect more trouble in short-term funding, losses from euro zone government debt and weak investment bank trading income.

In terms of book value, the sector is trading at an average of 0.6 times book value, compared to a 16-year average multiple of 1.6.

"The market is starting to price in writedowns of sovereign debt not only in Portugal, Greece and Ireland but also Italy and Spain and the associated recapitalisations ... It is getting pretty extreme," the fund manager said.

Barclays and Société Génerale shares are respectively trading at 4.4 times and 3.7 times earnings for the next 12 months, less than half their 10-year averages of around 9.5. BNP Paribas, Santander and Intesa Sanpaolo are also heavily discounted.

"Current prices suggest that the market is discounting much more than a moderate, medium-term earnings downgrade driven by weaker revenues," Leigh Goodwin, Citi analyst, said in a note.

"The market now fears widespread, enforced and dilutive recapitalisations lie ahead for the banks sector."

An immediate concern is over banks' funding. The pressure is most apparent for European banks in need of short-term dollar borrowings, after US money market funds cut their exposure to euro zone banks in recent months.

Concerns heightened this week after an unidentified euro-zone bank borrowed $500 million in one-week dollars from the European Central Bank, for the first time since February, signalling a possible squeeze in dollar funding.

Such strains are unlikely to escalate to the liquidity crisis seen during 2007 and 2008, however, because the ECB has put mechanisms in place to provide unlimited funds. But it will force banks to pay far more for their funding.

That could last for many years to come and is one of the structural shifts that will force banks to shrink, reshape and cut lending. Investors need to come to terms with lower returns that may struggle to hit mid-teen percent that many banks are targeting, analysts said.

"There are more structural issues that are preventing people from looking at the stocks, recognising they have come down a lot and identifying potential value," said David Miller, a partner at Cheviot Asset Management.

"I don't see much of that and wouldn't want to push money that way as a manager," he said.

Reuters