Preparing for the unknown: lessons from the ECB’s reverse stress test on geopolitical risk

11 September 2026

By Claudia Buch, Chair of the Supervisory Board of the ECB^[1][2]

It is difficult to predict when geopolitical shocks will occur and how severe they will be. Conflicts can escalate. Energy prices can rise. Shipping routes can come under pressure. Firms can face higher costs and delivery delays. Markets can reassess risk. Banks may quickly see the effects of these shocks through weaker borrowers, declining collateral values, deteriorating funding conditions, higher liquidity needs, or operational vulnerabilities.

Geopolitical risks are difficult to manage.^[3] Past data provide little guidance because risks can evolve and materialise in unforeseen ways. Preparing for different scenarios is challenging and potentially costly, requiring backup facilities and contingency planning.

Reverse stress testing provides a window into an unknown future. In a highly uncertain environment, banks need good scenario planning.^[4] Management and boards must understand how a severe geopolitical shock could affect a bank’s exposures, identify the channels through which a shock could propagate and prepare responses that can be used under pressure.

How the reverse stress test worked

The ECB’s 2026 reverse stress test examined how adverse geopolitical risks could affect banks’ risk profiles.^[5]

In a traditional stress test, like the one conducted every two years by the European Banking Authority (EBA), all banks use the same adverse scenario and calculate the quantitative impact on their capital.^[6]

A reverse stress test works differently.^[7] Our focus has been on qualitative questions: which event or combination of events could prove most material for this particular bank? How well can it analyse and prepare for them? How would shocks spread through its balance sheet and operations? Are the planned responses credible?

A reverse stress test focuses on differences in the drivers of a given, severe capital depletion across banks. It does not rank banks against one common scenario. The capital depletion outcome is specified at the outset, and banks work backwards to identify a scenario that could generate such a capital depletion. The scenario has to be relevant for the bank, and the bank has to explain the transmission channels to capital and liquidity and set out possible management measures that could preserve or restore resilience under stress.

Stress-testing is particularly important at the current juncture. It guards against complacency. In recent years, the euro area banking sector has generally shown strong capital and liquidity positions. Risk-taking is inherent in banking because banks provide critical services to the economy: they extend credit, transform maturities, and rely on funding markets. Sound risk management starts with a clear understanding of where banks’ balance sheets are vulnerable. A reverse stress test reinforces this discipline by asking which geopolitical scenario could have material effects.

Preparedness starts with reliable information systems

Geopolitical developments do not appear as a separate line in a bank’s accounts. Instead, they affect banks through traditional channels, including credit, market, liquidity, funding and operational risks.^[8] A supply-chain shock may weaken borrowers’ earnings. A confidence shock may affect asset prices and funding conditions. A cyber incident may disrupt operations and create financial consequences through lost income, higher costs or wider market stress.

Banks submitted different scenarios. Some centred on military escalation and disruptions to critical shipping routes, with effects on energy prices, trade flows and confidence. Others focused on sanctions, trade fragmentation, cyberattacks, hybrid threats, political instability or market repricing. Scenarios often combined several elements, as geopolitical stress can build up through interacting shocks rather than one isolated event. Around a quarter of banks explicitly referred to conflict in the Middle East, including the possible closure of the Strait of Hormuz, although the exercise was launched before tensions escalated in February 2026.

Translating an adverse scenario into concrete impacts requires good, granular data. The bank needs to know which borrowers, products or regions are most exposed to the shock. A supply-chain or energy shock will not affect all borrowers in the same way – some may depend on imported inputs or energy-intensive production, while others may sell mainly in markets affected by sanctions, trade restrictions or weaker demand. Some may have long-term supply contracts, hedges or cash buffers, while others may have less room to absorb higher costs or delivery delays.

Good information systems ensure that risk information is available when management needs to make decisions under pressure. This demands more than simply collecting data. Good data management requires consistent definitions, quality controls and reports that bring information together. Often, however, relevant data are siloed across different functions in a bank, causing valuable time to be lost in a crisis situation.

If relevant data cannot be reconciled quickly, the board may receive separate reports that do not give a coherent picture. Credit risk may be assessed without a clear view of liquidity needs. Liquidity reports may miss links to collateral values or credit-line drawdowns. Reports on operational dependencies may lack information on implied financial risks.

The reverse stress test showed areas for improvement: some banks need to assess in more detail how geopolitical risk would affect them. The remediation of weaknesses in risk data aggregation and risk reporting has in fact been one of the SSM supervisory priorities.^[9]

Boards need to assess resilience under different scenarios

Geopolitical risk cannot be managed by mechanically extrapolating data based on historical relationships. The next shock will be different. Scenario planning helps boards and management prepare for an uncertain environment: how the situation could evolve, which exposures could be affected and what decisions would be required as new information becomes available.

Scenario planning is a governance task, not only a technical one. Do the adverse scenarios capture the right vulnerabilities? How would the bank be affected? And would it be able to adjust without requiring external support? In short: would the bank be resilient and able to continue operating, even under adverse conditions?

The ECB’s reverse stress test asked banks to build a scenario that was severe, relevant and capable of explaining how geopolitical stress could affect the bank.

A scenario of market fragmentation, for example, affects funding structures, collateral needs and interest rates. Some banks clearly identified these links; others did not fully connect the scenario to the quantitative impacts. In some cases, second-round effects and interactions between risk channels were not well identified.

Solvency, liquidity and operational resilience are all part of the same story. During the global financial crisis, losses on assets, uncertainty about banks’ exposures and pressure in wholesale funding markets quickly interacted, affecting liquidity and solvency simultaneously.^[10] In a potential future crisis, the exact channels of transmission will be different, but the basic mechanisms will not. Today, cyber risks and hybrid threats add an additional layer of vulnerability to the picture.

Despite assuming a material depletion in capital, several banks projected only limited liquidity stress. Yet a scenario severe enough to affect capital would normally affect the cost and availability of funding. Foreign currency liquidity deserves particular attention. Some banks nevertheless projected limited or no variability in foreign exchange liquidity under stress. If banks rely on market-based funding, swap markets or foreign currency liquidity sources, they may thus underestimate rollover and funding pressures.

Management boards need stress-testing frameworks that make relevant feedback channels visible. A stress scenario that weakens borrowers, raises collateral needs or disrupts operations should provide a comprehensive view of what happens to funding, liquidity and capital.

If many are looking for the same exit, the exit might be blocked

Banks were asked how they would respond if an adverse geopolitical scenario materialised. They reported a broad range of measures. About 74% reported largely internal measures, such as improvements in ICT resilience and cyber recovery, while 60% reported enhanced monitoring and early warning measures. Other mitigating measures depend on market conditions, counterparties or client behaviour: 40% reported portfolio sales or asset disposals, 39% deposit or loan repricing, 35% funding mix optimisation and 22% a capital injection or issuance of shares. Banks estimated that these measures would recover about half of the depleted capital.

Banks need to make realistic assumptions about whether mitigating measures would be available in a crisis. A measure that looks feasible for one bank alone may become less effective or not be available if many other banks want to use it at the same time.

In a crisis, raising capital can become more expensive when equity valuations are under pressure.^[11] Market-based measures looking at an individual bank’s capital shortfall, conditional on a shortfall in the market, show this quite clearly. For several larger European banks, estimates of their systemic impact on the market are indeed quite sizeable.^[12] Hence, market stress can increase the capital needs of banks precisely when valuations weaken, making capital measures harder to execute.^[13]

In addition, fire sale dynamics can suppress asset prices. When sellers are under pressure to act quickly, bargaining power shifts to buyers. Asset sales may depress prices, crystallise losses, and provide less liquidity than expected.^[14]

Moreover, expanding the balance sheet is unlikely to be feasible in a crisis. In the adverse scenario, banks projected significantly lower asset growth than in their baseline scenario, but the simulations did not point to widespread deleveraging. Some banks, which tend to be the ones with higher capital ratios, even projected positive asset growth under stress.

Not least, realism requires sound assumptions about monetary and fiscal policy responses to a shock. In the stress test, banks were asked to assume that fiscal policy would not respond to a shock. During the COVID-19 pandemic and the recent energy crisis, fiscal support to the economy and, therefore, indirectly to banks was quite significant. Yet fiscal space has become more limited, and banks cannot assume similar support for the economy in the future.

As regards monetary policy, banks were allowed to reflect changes in the monetary policy stance, for example through policy rates, when calibrating their scenarios. These assumptions need to be consistent across scenarios in terms of interest-rate sensitivity of earnings, market valuations, funding costs and liquidity.

This is the systemic perspective that reverse stress testing can bring. Banks must allow for the possibility that, in a crisis, access to funding and market liquidity could dry up. Good scenario planning therefore needs to factor in the fact that other banks rely on similar measures.

Conclusion

Geopolitical uncertainty will remain a feature of the risk environment and a priority for European banking supervisors.^[15] Banks need to prepare for the unknown.

The 2026 reverse stress test brought three messages into focus. Preparedness starts with granular information: banks need reliable data to assess how a geopolitical shock could hit them. Boards need to ensure that banks can flexibly adjust to different scenarios and remain resilient – financially and operationally. And measures taken by management need to be realistic: if many banks are looking for the same exit at the same time, that particular exit may be blocked.

Sound capital planning remains key for banks’ resilience. They need to understand how capital could come under pressure, how liquidity and operational risks could amplify shocks, and which measures would still be available under stressed market conditions. Reverse stress tests are an important tool in our supervisory toolbox: they enable us to assess whether banks have the right frameworks in place to ensure sound capital planning.