Probability & Partners: Geopolitical risk and the robustness of banks

November 18, 2025

_{This column was originally written in Dutch. This is an English translation.}

By Gerd-Jan van Wiggen, Partner at Probability & Partners

Current geopolitical dynamics are having an increasing impact on the financial sector. Trade conflicts, technological dependencies, cyber threats and market fragmentation are creating an environment of uncertainty. For banks — cyclical businesses that are closely intertwined with the real economy — such major shocks pose a direct threat to profitability, stability and risk management.

Since the summer of 2024, we have focused on this topic more frequently (see, among others, Pim Poppe in Financial Investigator, ‘Are country risks making a comeback?’, ‘Drenched in sweat’ and ‘How crazy can it get?’). When supporting our clients with our risk assessments and developing scenarios, we see in practice how unruly these dynamics are.

Although European banks are currently well capitalised and have ample liquidity buffers, their resilience to the consequences of geopolitical events remains uncertain. New transmission mechanisms, such as indirect exposures via private credit markets and the growth of cryptocurrencies and stablecoins, can also cause unexpected contagion effects.

All of this has led both the ESAs (European Supervisory Authorities) and the ECB to reflect on this issue and issue recommendations.

The ESAs' perspective: uncertainty has increased

The Joint Committee of the three ESAs — the European Banking Authority (EBA), the European Insurance and Occupational Pensions Authority (EIOPA) and the European Securities and Markets Authority (ESMA) — emphasises that geopolitical uncertainties have structurally lowered economic growth expectations for the euro area. Import duties and other trade barriers are leading to disruptions in supply chains and investor caution, which is translating into lower credit demand and higher risk premiums.

Financial institutions are therefore urged to explicitly integrate geopolitical risks into their daily risk management processes. This means not only incorporating more traditional scenarios involving market corrections or interest rate volatility, but also systematically analysing indirect exposures — for example, through customers operating in geopolitically sensitive sectors or regions.

In addition, regulators point to the increased number of cyber incidents and the growing dependence on third parties for (critical) IT services. This makes institutions more vulnerable to disruptions arising from international tensions or sanctions regimes. This makes the implementation of the Digital Operational Resilience Act (DORA) even more urgent: operational resilience is seen as an integral part of good risk management.

The ECB perspective: buffers and stress tests in an uncertain world

The European Central Bank (ECB) has also tightened its stance on geopolitical risks. From a macroprudential perspective, the ECB emphasises the need to strengthen capital buffers, particularly to absorb system-wide uncertainties. Instruments such as the countercyclical capital buffer (CCyB) can be used by supervisors to counter contagion effects and feedback loops from the real economy.

The ECB points out that traditional stress test methodologies are insufficient to capture the impact of geopolitical scenarios. Historical data are not necessarily representative of future shocks. Recent crises — such as the COVID-19 pandemic and the energy crisis — were partly mitigated by substantial government support, which means that the link between macroeconomic deterioration and credit losses is underestimated in a situation where such support is lacking or cannot be sufficiently regulated. Furthermore, structural changes, such as shifts in trade flows and sectoral sensitivities to import tariffs, may lead to effects that are not captured by current models.

To gain a better understanding of vulnerabilities, the ECB conducts periodic stress tests in cooperation with the EBA. The EBA stress test, which takes place every two years, is based on a static balance sheet and a three-year time horizon. In the intervening years, the ECB conducts its own additional stress tests. Next year, the ECB will conduct a reverse stress test specifically focused on geopolitical risks.

The aim of this approach is to identify events that could have a significant impact on banks' capital ratios. Each bank has its own sensitivity to geopolitical events, for example as a result of a specific sector focus or the chosen business model. In a reverse stress test, banks are asked to analyse which events could lead to a decline of a few hundred basis points in the CET1 ratio. The results reveal weaknesses in the financial system and can lead to specific measures being taken to prevent major risks from occurring or to limit their impact. Examples include adjustments to dividend policy in order to build up capital buffers, adjustments to the business plan, and reducing exposure in certain sectors or to certain counterparties.

Critical comments and implications for banks

The call by regulators to strengthen capital buffers and improve risk management is justified. At the same time, it is questionable whether increasing capital buffers is the most effective measure. On the one hand, we see that capital requirements are being lowered in some jurisdictions, which could put European banks at a competitive disadvantage. On the other hand, relatively simple measures, such as building redundancy into systems, can have a greater impact on a bank's stability at a lower cost compared to higher buffers.

Conclusion

The geopolitical uncertainties facing the global economy in 2025 are greater and more diffuse than in previous years. Both the Joint Committee of the ESAs and the ECB emphasise that financial institutions must incorporate geopolitical risks into their risk management processes and capital planning. Developing plausible scenarios is one of the most important tools in this regard.

At the same time, the importance of operational resilience is growing. The implementation of DORA and stricter Third-Party Risk Management and Outsourcing guidelines will help in this regard.

The key message is therefore that banks must not only prepare for the usual economic cycles, but also for the unpredictable consequences of geopolitical fragmentation. Only through a combination of solid capital and liquidity buffers, integrated risk management and robust operational structures can institutions maintain their stability in a world where geopolitics is increasingly influencing financial reality.

At Probability & Partners, we recommend taking the recommendations of ESMA, the ECB, EIOPA and the Joint Committee to heart. One caveat is that resilience should not be sought primarily in capital, but above all in pursuing operational redundancy and improving flexibility in the business and operational model. We call this scenario-agnostic resilience. Since the summer of 2024, we have been working with various clients to help them. For us and our clients, this is a new, challenging and, above all, important area of risk management that will gain in professionalism and urgency with the recommendations.