We discuss the current state of the European banking system and the major challenges for the future. The low interest rate environment may give rise to asset price bubbles and interest rate risk, which should be counteracted by macroprudential regulation. Overcapacities in banking should be reduced by resolving banks that do not pass the ECB's comprehensive assessment. The link between banks and sovereigns could be alleviated by reforming the regulatory treatment of government bond holdings and by establishing a credible backstop for the Single Resolution Mechanism. Finally, the fragmentation of the European financial system may be tackled through greater harmonisation and by improving resolution procedures for cross-border banks.