The European Central Bank (ECB) announced details on upcoming stress tests to measure banks’ resilience amid global uncertainty. The test will assess how well banks can withstand severe economic shocks over a three-year period (2025-2027), with a focus on whether their capital levels are sufficient to maintain stability and support the economy in times of distress.
- ECB to examine 51 of euro area’s largest banks as part of regular European Banking Authority (EBA)-led EU-wide stress test
- ECB to conduct parallel stress test for 45 banks outside EBA sample
- Insufficiently prudent submissions to be subject to additional scrutiny, including on-site visits
- Additional counterparty credit risk analysis to be used to assess banks’ modelling abilities and vulnerabilities from links with non-bank financial intermediaries
The ECB will conduct a scenario analysis of counterparty credit risk (CCR) for selected banks. This will allow supervisors to gauge how well banks can model CCR under stressed market conditions and assess how vulnerable banks are owing to interlinkages with non-bank financial intermediaries. This will ultimately help to address shortcomings in banks’ credit risk and CCR management frameworks. Aggregate results of the CCR exploratory scenario will be published together with those of the ECB stress test in early August.
This year’s exercise comes with a hypothetical worst-case scenario centered around a sharp escalation of geopolitical tensions amid concerns that the new Trump administration could enforce protectionist economist policies such as trade tariffs on the EU.
Under this scenario, the global economy suffers from protectionist trade policies, disrupted supply chains, and a decline in business confidence, resulting in a 6.3% contraction in EU GDP by 2027. The adverse environment would also cause a significant rise in unemployment, with the rate projected to be 6.1 percentage points higher than its baseline. Inflation would spike before gradually easing back.
Jo Burnham, Risk and Margining subject matter expert at OpenGamma, said in emailed commentary: “The EBA’s stress test is vital in pushing European banks to confront worst-case scenarios. But it’s not just about the banks. In 2025, stress testing could become more relevant to firms in terms of their derivatives positions. With many hedge funds diving into commodities to capitalize on the volatility, there’s growing concern about how these positions might impact their liquidity requirements. Regardless of how markets move in response to geopolitics, the reality is that stresses will happen, and there’s a real risk that market participants might not react in ways that effectively manage those events.”