ECB reverse stress test puts geopolitical risk into focus

Geopolitical risk has become an increasingly important part of banking supervision.

It is one of the ECB’s supervisory priorities for 2026-28, with particular attention being paid to how banks incorporate geopolitical events into capital, liquidity and recovery planning. Against this backdrop, the ECB has completed a thematic reverse stress test involving 110 euro-area banks under its direct supervision.

A different approach to stress testing

Unlike a traditional stress test, the 2026 exercise did not give all banks the same adverse scenario.

Instead, the ECB defined the outcome and asked banks to work backwards.

Banks were given a target of 300 basis points of CET1 ratio depletion and asked to develop a geopolitical scenario severe enough to produce such an impact. They then assessed how that scenario could affect their solvency, liquidity and non-financial risks.

This makes the exercise fundamentally different from the biennial EU-wide stress test carried out with the European Banking Authority.

In a traditional stress test, the scenario comes first and the capital impact is calculated afterwards. In a reverse stress test, the starting point is the capital impact, with banks then identifying the combination of events and transmission channels that could lead to it.

The objective is therefore less about comparing banks against a common scenario and more about assessing how well institutions understand their own vulnerabilities.

What scenarios did banks consider?

Banks developed a wide range of geopolitical narratives based on the risks most relevant to their individual activities.

Common trigger events included:

• military conflicts;
• supply-chain disruption, including energy supply disruption;
• economic sanctions;
• macroeconomic confidence effects;
• political instability; and
• cyber-related attacks.

Around a quarter of participating banks explicitly included a Middle East conflict, including a potential closure of the Strait of Hormuz. Other frequently cited scenarios involved further escalation of the war in Ukraine, China-US trade disruption and tensions in the Taiwan Strait.

The ECB asked banks to consider how such events could transmit through three broad channels: financial markets, the real economy, and safety and security.

Banks generally produced meaningful scenarios

The overall findings are broadly constructive.

According to the ECB, banks generally demonstrated an ability to translate geopolitical events into economically meaningful impacts on capital, income and liquidity.

Depending on the scenario, the main effects on capital came through channels such as credit losses and lower net interest income. For banks with larger capital-markets activities, lower fee income and trading income could also play a role.

The impact of geopolitical stress also varied considerably by sector and business model, underlining the importance of sufficiently granular assessments.

Liquidity positions generally remain above regulatory thresholds

The exercise also considered liquidity and funding.

The ECB found that banks’ regulatory liquidity positions generally remained above minimum requirements under their self-designed geopolitical scenarios.

The median Liquidity Coverage Ratio declined from 186% at the starting point to 163% after one year, remaining above the 100% regulatory threshold. Foreign-currency liquidity showed greater variation across institutions.

The exercise nevertheless highlighted the importance of continuing to strengthen the way solvency and liquidity risks are considered together in stress-testing frameworks.

Cyber risk features prominently

Although the exercise focused mainly on financial risks, banks were also asked to identify the non-financial risks that could arise under their geopolitical scenarios.

Cyberattacks were the most frequently reported disruption type.

Of the 110 participating institutions, 86 identified cyberattacks as relevant and 57 ranked them as their main non-financial disruption type. Other recurring risks included disruption of services from third-party providers and disruptions affecting clients, products and business practices.

This reinforces the increasingly close connection between geopolitical risk and operational resilience.

Lessons for stress-testing frameworks

Alongside its broadly positive findings, the ECB identified several areas where banks can continue to enhance their frameworks.

These include:

• greater granularity and sensitivity in risk assessments;
• consideration of multiple scenarios;
• stronger consistency between scenario narratives and their impact on solvency and liquidity;
• prudent dynamic balance-sheet projections;
• realistic mitigating actions, particularly in systemic stress situations; and
• better articulation of the interaction between solvency and liquidity.

These are particularly relevant in an environment where geopolitical risks can materialise through several channels simultaneously.