Stress tests in uncertain times: assessing banks’ resilience to external shocks

5 September 2025

By Claudia Buch, Chair of the Supervisory Board

Resilient banks contribute to economic welfare. Banks with sufficient capital buffers can absorb shocks without cutting down on lending or curtailing essential financial services for households and businesses. They can support economic transformation and broader policy objectives by adjusting their lending portfolios to the needs of the real economy. Resilience and growth go hand in hand.

Resilience is a forward-looking concept. How would banks fare under adverse conditions? Are they financially equipped to deal with unforeseen losses, liquidity squeezes, downward spirals in asset prices, or shifts in investor sentiment? Are they operationally sound enough to cope with IT and cyber risks? All these are valid concerns stakeholders raise about the banking sector.

Stress testing is a key tool to address such concerns. Both banks and supervisors conduct stress tests: banks use them internally to guide capital planning and risk management, while supervisors run system-wide exercises to ensure resilience across the sector. ECB Banking Supervision’s solvency stress test provides a harmonised, forward-looking assessment of how banks would cope with adverse economic conditions. It is designed to determine banks’ capital adequacy, bolster their risk management capabilities, identify vulnerabilities to emerging risks and build public confidence in the banking sector. This process enhances transparency and reinforces market discipline.

But stress tests alone cannot capture the full range of risks and uncertainties banks face. Banks need sound risk management and scenario analysis frameworks to scan the horizon and respond to emerging risks. Supervisors use additional tools to focus on specific risks, including thematic stress tests and targeted assessments of banks’ risk areas. Macroprudential policy has a key role to play in addressing risks to financial stability.

The ECB solvency stress test: assessing banks’ resilience to a common adverse scenario

The ECB solvency stress test is designed to assess the impact of adverse macroeconomic shocks on bank capital over a three-year horizon. The test analyses how banks’ capital positions would evolve under a baseline and an adverse scenario. The adverse scenario is developed by the European Systemic Risk Board (ESRB) as a hypothetical but plausible one.^[1] In the 2025 stress test, the effects of an escalation of geopolitical tensions that disrupts trade, triggers heightened uncertainty and leads to a contraction in growth are simulated. In this scenario, the inflationary impact is muted, as higher input costs are offset by weaker demand. But rising market interest rates and corrections in asset prices could add to banks’ challenges.

This year, the stress test conducted by ECB Banking Supervision included 96 significant institutions. Of those, 51 of the largest significant institutions under the ECB’s direct supervision participated in the EU-wide stress test coordinated by the European Banking Authority (EBA). These banks account for around 75% of total banking assets in the euro area. An additional 45 medium-sized significant institutions, accounting for 7% of assets, took part in a parallel stress test coordinated by the ECB. The stress tests are carried out at regular intervals under the legal framework established by the Capital Requirements Directive and are coordinated at EU level by the EBA, with the ECB responsible for implementation for significant institutions.

The stress test design ensures comparability of results across banks and countries. All banks follow a common methodology, and the balance sheet of each bank is assumed to remain unchanged throughout the scenario. In other words, there are no adjustments of business models, reductions of exposures or issuances of additional capital. The stress test uses banks’ balance sheet data at year-end 2024 to project how banks’ capital positions will develop under stress over a period of three years, to the end of 2027. This uniform approach helps us identify vulnerabilities and track resilience consistently across the banking system.

The stress test provides valuable input for the Supervisory Review and Evaluation Process (SREP). In quantitative terms, the test assesses banks’ ability to withstand shocks by estimating potential losses and the capital available to absorb them. The stress test results are used as a starting point for setting the Pillar 2 guidance (P2G), which reflects the capital buffer a bank is expected to maintain to remain resilient under stress. Generally, greater capital depletion in the stress test implies a higher P2G, but supervisors also apply judgement to take bank-specific aspects into account then setting the P2G.^[2] Qualitative findings such as the accuracy and timeliness of information provided by the banks inform supervisors about the overall soundness of banks’ risk management.

The results of the 2025 stress test show that the euro area banking sector would remain resilient against a severe economic downturn. At the end of the projection horizon, the system-level CET1 ratio would stand at 12.0% under the adverse scenario and 17.1% under the baseline. This represents an improvement compared with two years ago, when the stressed CET1 ratio was 10.4%, and compared with the 2014 comprehensive assessment, when it was only 8.5%.

Chart 1

Evolution of system-level CET1 ratios before and after stress in supervisory stress test exercises conducted in the EU

Aggregate CET1 capital ratio at the starting point and end of the three-year adverse scenario

(percentages of REA)

Beyond the stress test: scanning the horizon and capturing economic uncertainty

The ECB solvency stress test provides a consistent benchmark for assessing the banking sector’s resilience against a common adverse scenario. But it needs to be complemented by additional tools to capture other relevant dimensions of risk. This is particularly relevant in today’s environment, where the macro-financial outlook remains highly uncertain amid elevated geopolitical risks. This uncertainty, moreover, is compounded by structural challenges stemming from demographic shifts, digitalisation and climate change.

Uncertainty is not measurable. Much of the current uncertainty is “radical” in nature:^[3] the future is not just unknown, but unknowable. Assigning probabilities to potential future outcomes – which is the basis for traditional risk measurement – is often not feasible. Consequently, risk assessment models based on historical data or specific scenarios will be unable to account for relevant sources of uncertainty.

Good risk management therefore needs to rely on a broad range of tools and an informative dashboard to navigate this uncertainty, just as banks would not rely on a single metric or model to guide their decision-making in the face of the unexpected.

From a supervisory perspective, the limitations of solvency stress tests are addressed in two ways. The first is to mitigate methodological constraints within the stress test framework. The second is to draw on a wider set of tools and perspectives.

Allowing for dynamic balance sheets

The static balance sheet assumption underlying the solvency stress test ensures comparability across banks by requiring that business models, portfolios and capital positions remain unchanged over the three-year horizon. The stress test thus focuses on the direct, first-order impact on individual banks. In a real stress situation, however, banks would take corrective actions – such as restructuring portfolios, deleveraging, adjusting funding strategies or raising capital. By design, the stress test does not capture this kind of adaptive behaviour. For the purpose of calibrating the P2G, supervisors can take into account planned balance sheet adjustments or other mitigating actions at the individual bank level.

At the aggregate level, macroprudential capital buffers are calibrated to help absorb losses materialising after systemic shocks and to address vulnerabilities built up endogenously in the financial sector. The macroprudential policy process includes an assessment of dynamic bank reactions and their wider economic implications of adverse shocks. The results of such analysis are regularly published by the ECB following the EU-wide stress test.^[4]

Addressing structural breaks and emerging risks

As a bottom-up exercise, the stress test relies primarily on banks’ internal models and tools to assess potential losses. While this has its benefits, it comes with drawbacks, as existing modelling frameworks may not sufficiently capture structural breaks. At the current juncture, banks’ internal models may underestimate losses in an adverse scenario. This is because recent severe shocks to the real economy – the pandemic or the energy crisis – have largely been absorbed by fiscal policy, mitigating the impact on banks’ balance sheets. Models based on past data may therefore assume an unrealistically low correlation between macroeconomic developments and credit losses.

The stress test addresses these drawbacks through model overlays and the quality assurance process.

Overlays are adjustments to model outcomes that aim to capture features not fully accounted for in the models.^[5] They are closely linked to loan loss provisioning under IFRS 9 accounting standards, where they serve as a tool to quantify risks for which there are insufficient historical data. Banks have used overlays to take into account risks such as energy supply disruptions, higher inflation, climate risks and geopolitical shocks. Overlays can ensure that such risks are factored into expected credit losses and, ultimately, banks’ capital ratios. However, their effectiveness depends on robust methodology and governance, and current practices vary widely across banks. Some banks apply broad “umbrella” overlays that fail to capture sectoral differences or that understate vulnerabilities.^[6]

In addition, during their quality assurance process, ECB supervisors review model-based projections with banks to correct any deficiencies or underestimations of risk. Additionally, the bottom-up nature of the ECB solvency stress test encourages banks to invest in their models, which may also lead to adjustments to their risk-taking behaviour.^[7]

Accounting for sectoral effects

The stress test focuses on the potential implications of adverse macro-financial developments, in particular those arising from geopolitical risks. Yet, the impact of, say, tariff increases can be very sector-specific, and may vary greatly even within sectors. Ultimately, this means banks need to understand how their individual corporate clients are exposed to adverse global developments. The stress test alone cannot substitute for the risk assessment that is needed, but it still offers valuable insights and incentivises banks to develop the respective tools.

In the 2025 stress test, banks provided sector-specific loan loss projections to account for sectoral vulnerabilities. Overall, banks’ sectoral modelling capabilities have improved since the previous stress test in 2023. Loan loss projections have become more sensitive to sector-specific shocks. However, limitations remain: many banks lack dedicated models for different sectors, and their models vary widely in quality and comprehensiveness. There is significant room for improvement in modelling sectoral and firm-specific risks.

Capturing broader risks

The stress test exercise focuses on credit risk, market risk, operational risk and risks to certain net revenue items.^[8] However, other types of risk – most notably cyber risk – are not explicitly captured, despite their growing relevance. Similarly, structural vulnerabilities such as weak governance, ineffective internal controls and poor risk culture are not directly addressed in the test. This requires supervisory judgement and the use of complementary tools.

To address risks outside the scope of the stress test exercise, ECB Banking Supervision has carried out targeted reviews on emerging risks in areas such as commercial real estate, private credit and leveraged finance. Thematic stress tests have been used to assess specific vulnerabilities, such as banks’ exposure to interest rate risk (2017), liquidity risk (2019) and climate risk (2022), and their cyber resilience (2024).^[9]

The 2026 thematic stress test will take the form of a reverse stress test on geopolitical risk. Based on each bank’s unique risk profile, it will explore which geopolitical shocks and transmission channels could most severely affect banks’ profitability and solvency. Reverse stress tests provide a different perspective from standard solvency stress tests: instead of assessing how a bank performs under a given, common scenario, they begin by asking what kind of shock would lead to a severe capital depletion in an individual bank. This helps identify bank-specific vulnerabilities and challenge assumptions about risk exposures, providing important input to the dialogue between banks and supervisors on contingency planning and risk management.

Addressing contagion and systemic effects

As a microprudential tool, solvency stress tests focus on the direct, first-order impact of macroeconomic shocks on individual banks. They help assess whether banks would remain resilient and continue to meet their minimum capital requirements in such scenarios. However, they do not model liquidity dynamics, contagion effects or feedback effects to the real economy – all of which can amplify shocks across the system.

In a stress scenario, market participants will expect banks to remain sufficiently capitalised. The minimum capital ratio expected by the market may be higher than the regulatory capital requirement. One systemic risk metric that can be used to measure this is SRISK, which captures the vulnerability of banks as perceived by the market and implicitly incorporates factors such as market contagion, investor sentiment and the capital needs of other banks in the system.^[10] For European banks, SRISK increased during the global financial crisis and has remained persistently elevated.^[11] These metrics underline the importance of having sound macroprudential frameworks in place to address systemic risk issues, as well as the need to close gaps in resolution frameworks and complete the banking union.

Macroprudential capital requirements capture such systemic effects. The countercyclical capital buffer (CCyB) in particular is designed to safeguard the functioning of the financial system as a whole. The CCyB provides an extra layer of capital that can be released in times of widespread stress and ensures that banks can continue lending to the real economy without breaching regulatory thresholds or having their solvency called into question. As such, it helps prevent the materialisation of externalities from bank losses and a collective deleveraging spiral. The micro- and macroprudential approaches complement one another – and both are essential for maintaining financial stability.

Overall, stress tests open an important window into an uncertain future. They are an essential element of banks’ risk management and of our supervisory assessment. But they do not resolve the uncertainty that surrounds us, which is why they need to be complemented by a range of other tools. At the bank level, managing geopolitical risk must be a priority for management bodies and boards. At the supervisory level, we are employing different tools to address bank-specific vulnerabilities that stress tests cannot capture.

Macroprudential policies address systemic vulnerabilities in the financial system. Elevated risks to financial stability and heightened geopolitical uncertainty mean that preserving the resilience of the banking system must remain a key focus for macroprudential policy.^[12] Not least the pandemic has shown that it is important to build up macroprudential space through a releasable macroprudential buffer at an early stage of the financial cycle. By now, all countries in the banking union have such buffers in place, and already about half of the countries follow an explicit early activation approach for the CCyB.^[13]

The views expressed in each blog entry are those of the author(s) and do not necessarily represent the views of the European Central Bank and the Eurosystem.

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