Banks resilient to ECB's geopolitical stress tests, but improvements needed

European banks have demonstrated general resilience against geopolitical crises, including wars, supply chain disruptions, and cyberattacks, according to the European Central Bank (ECB). However, the central bank suggests there is still significant room for improvement in how banks manage these risks.

In a novel approach, the ECB moved beyond traditional stress tests. It tasked 110 supervised banks with developing their own geopolitical scenarios. These "reverse stress tests" aimed to assess the potential impact on the Common Equity Tier 1 (CET1) capital ratio, targeting a reduction of 300 basis points. This benchmark was chosen to reflect a substantial system-wide capital decrease, aligning with historical crisis episodes like the global financial crisis and the Eurozone sovereign debt crisis.

The exercise revealed that a conflict in the Middle East was explicitly cited as a major risk by a quarter of the banks. Common geopolitical scenarios included military conflicts, supply chain disruptions (particularly energy), economic sanctions, impacts on macroeconomic confidence, political instability, and cyberattacks. Across these scenarios, credit risk and profitability pressures were identified as key channels through which geopolitical shocks translate into capital impacts.

While banks' liquidity positions generally remained above minimum regulatory requirements under the tested scenarios, the ECB expressed dissatisfaction with certain calculation methods. "The exercise revealed inconsistencies in how some banks translated shocks into capital and liquidity impacts," the ECB stated. Each bank will receive a specific assessment of its performance, including key observations, followed by individual meetings.

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The exercise revealed inconsistencies in how some banks translated shocks into capital and liquidity impacts.