ECB Identifies Areas for Improvement in Euro Area Banks' Stress Testing

The European Central Bank (ECB) has completed its examination of 110 entities under direct supervision, including banks in the euro area. The thematic examination of 2026 required banks to conduct a reverse stress test, assessing their ability to identify plausible geopolitical scenarios severe enough to significantly deteriorate their capital levels.

The ECB set a benchmark of a drop of 300 basis points in the common equity tier 1 (CET1) capital ratio and asked entities to construct scenarios based on a detailed analysis of geopolitical risk that would lead to that outcome. The approach focuses on each entity's ability to assess how geopolitical risks could impact their business model.

The ECB emphasized that banks were able to generate economically relevant stress scenarios that reflected their individual vulnerabilities, incorporating armed conflicts, disruptions in trade, energy and supply chains, economic sanctions, macroeconomic crises, and cyber incidents. The supervisor noted that the diversity of scenarios highlights the ability of banks to adapt their stress tests to their specific business models and risk profiles.

However, the ECB warned that the exercise also highlighted areas where improvements are needed, including the accuracy and sensitivity of risk assessments, the consistency between scenario narratives and their effects on solvency and liquidity, and the realism of mitigation measures in systemic crisis environments. The supervisor pointed out that several banks showed a moderate response to their liquidity indicators despite significant capital decrease anticipated in the scenario.

The ECB emphasized that the responses proposed by entities were 'plausible and relevant' for the analyzed scenario but detected cases where the assumptions were 'excessively optimistic', such as assuming loan portfolios could be sold or raising capital at ambitious prices in an adverse market context. The supervisor expects to follow up with affected entities within the framework of ongoing dialogue on capital planning and recovery plans.