LONDON, June 25 (Reuters) - Although a better economy is helping global banks to turn the corner a decade after the financial crisis began, euro zone lenders remain a dampener on the sector's recovery, the Bank for International Settlements said on Sunday.
"The financial sector faces an improving but still challenging environment," the BIS, a forum for central bankers, said in its annual report.
"The near term economic outlook has brightened substantially and financial headwinds have turned into tailwinds in many advanced economies."
Banks should use the "growth dividend" to increase their resilience to market shocks and reshape business models, it added. An improved economy will stop the rise in non-performing loans (NPLs) whose repayments have fallen behind.
"That said, the banking systems in some jurisdictions still look vulnerable to a further deterioration in credit quality. In a number of euro area countries, for example, the share of NPLs remains stubbornly high."
Euro zone authorities had to intervene in struggling Spanish bank Banco Popular earlier this month, and face pressure to sort out some of Italy's problem lenders as well.
But economists say that Europe was hit by two crises - one financial, the other related to euro zone countries' debt. In the meantime, U.S. banks have benefitted from their main market being in a stronger phase of the economic cycle - though the euro zone economy is recovering.
Europe, however, is widely seen as being slower and less aggressive in tackling struggling banks compared with the United States, and the region is still "overbanked".
The BIS said banks globally have made progress in cutting leverage and diversifying income, but market valuations for many lenders still point to investor scepticism, the BIS said.
The price to book ratio of euro area lenders remains below 1, meaning a bank's market value is less than its balance sheet, it added.
The gap between observed and required returns-on-equity has narrowed, but in Europe the gap widened most recently, highlighting persistent pressure to further improve profitability, the BIS said.
BIS economic adviser and head of research, Hyun Song Shin, said European banks were also helping to give the impression that finance globally, as measured by cross-border lending, was in headlong retreat.
"The consolidated perspective makes clear that the shrinkage of international banking is largely confined to European-headquartered banks," Shin said.
"The other banking systems actually increased foreign claims in relation to world GDP."
(Reporting by Huw Jones; Editing by Angus MacSwan)