ECB's First Reverse Stress Test Reveals Banks Unprepared for Geopolitical Shocks

On 31 July 2026, the ECB published the results of its first geopolitical risk reverse stress test, covering 110 euro area banks under direct ECB supervision . The exercise required each bank to design its own plausible geopolitical scenario that would deplete its Common Equity Tier 1 (CET1) capital ratio by at least 300 basis points, then identify and assess its vulnerabilities and proposed mitigating actions . The results revealed significant shortcomings in banks' ability to capture solvency-liquidity interactions, particular vulnerabilities in foreign-currency liquidity management, and ECB concerns that many proposed mitigating actions were overly optimistic or insufficiently granular .

How the Reverse Stress Test Worked

Unlike a traditional stress test, which starts with a hypothetical adverse scenario and measures its impact, a reverse stress test prescribes a predetermined outcome — in this case, a CET1 capital depletion of at least 300 basis points — and asks each bank to work backward to find the scenario that would cause it . The ECB announced the exercise in December 2025, and it complemented the 2025 European Banking Authority stress test, which assumed a common scenario for all banks .

Banks were required to model three transmission channels of geopolitical risk: the direct impact on the bank's exposures, the macroeconomic feedback effects, and the behavioural responses of customers and counterparties .

The Scenarios Banks Designed

The full range of bank-designed scenarios included:

• Trade wars and tariff escalations
• Sanctions regimes
• Cyber attacks on critical financial infrastructure
• Armed conflicts, including escalation of the war in Ukraine
• Hybrid warfare targeting energy supplies or other strategic sectors

The ECB noted that banks were generally able to produce economically meaningful stress scenarios reflecting their individual vulnerabilities . However, significant weaknesses emerged in how banks analysed their own exposures.

Foreign-Currency Liquidity: A Critical Weakness

The reverse stress test revealed that solvency-liquidity interactions are generally not well captured in many banks' stress-testing frameworks . Many banks assumed liquidity positions would remain above regulatory thresholds even under severe geopolitical stress, without adequately modelling how a solvency shock could trigger simultaneous liquidity outflows .

A specific vulnerability emerged around foreign-currency liquidity. Banks with significant cross-border exposures or reliance on foreign-currency funding underestimated the speed and severity of foreign-currency liquidity drains during a geopolitical crisis, especially in scenarios involving sanctions that could freeze or restrict access to certain currency markets . Under the bank-specific scenarios, median liquidity coverage ratios fell from 186% to between 150% and 185%, but many banks' models failed to capture a simultaneous liquidity crunch across currencies .

ECB Concerns About Proposed Mitigating Actions

The ECB found inconsistencies in how banks approached the exercise and judged that some banks' proposed mitigating actions reflected excessive optimism . Many banks relied on standard management actions such as asset disposals, capital raisings, or reductions in risk-weighted assets that may not be executable under the stressed conditions of a geopolitical crisis — for instance, asset sales at "fire sale" prices or the impossibility of raising capital quickly when markets are disrupted .

The ECB highlighted that banks' contingency plans often lacked sufficient detail on which specific instruments or counterparties would be used. They also failed to account for the fact that many mitigating actions would lose effectiveness precisely when multiple banks attempt them simultaneously .

Implications for Banks and Supervisors

The exercise signals that the ECB expects banks to materially improve their geopolitical risk modelling, particularly around liquidity-solvency linkages and foreign-currency stress scenarios. The ECB's 2025 stress test had already projected €628 billion in losses from deteriorating credit, market, and operational risk under an adverse scenario tied to geopolitical fragmentation . The reverse stress test results suggest that banks' planning for geopolitical crises remains incomplete.

The ECB and the European Systemic Risk Board have previously warned that geopolitical fragmentation poses significant financial stability risks, and regulators have advised financial institutions to continue incorporating geopolitical risk into day-to-day risk assessments . Banks that fail to address the shortcomings identified in the reverse stress test may face increased supervisory scrutiny or capital add-ons.