The ECB will reverse stress-test banks on geopolitical risks in 2026

In recent years, the global financial landscape has been fundamentally reshaped by escalating geopolitical tensions. Fragmentation, trade protectionism, cyber threats and supply chain disruptions have all contributed to a new era of systemic risk. Traditional risk models, which often rely on historical data and linear projections, are increasingly inadequate for capturing the complexity and unpredictability of these shocks. Against this backdrop, the limitations of traditional stress testing frameworks in reflecting geopolitical transmission channels are becoming more visible.  

In this context, the European Central Bank (ECB) has announced that its 2026 thematic reverse stress test will focus on geopolitical risk, employing a reverse stress-testing methodology to probe the resilience of European banks in the face of extreme but plausible scenarios. The exercise is positioned as a targeted thematic assessment aligned with the bank’s 2026 capital and liquidity planning cycle. The ECB confirmed that this reverse stress test will not directly affect into Pillar 2 Guidance (P2G). However, its findings will inform the Supervisory Review and Evaluation Process (SREP) indirectly affecting the Pillar 2 Requirement (P2R), which remains anchored in the SREP framework. 

Reverse stress testing represents a distinct supervisory variant to traditional stress tests. Rather than starting with a hypothetical adverse scenario and measuring its impact, banks are asked to identify the specific set of geopolitical events that could push them to a critical point of failure, such as breaching capital thresholds or threatening their viability. This approach is designed to uncover hidden vulnerabilities, challenge assumptions and foster a culture of forward-looking risk management.  

Upcoming ECB reverse geopolitical stress testing specifics 

Traditional stress testing typically assesses the impact of predefined macro-economic scenarios on banks’ capital and liquidity position. The core question is, “If this event occurs, what would be the consequences for our organisation?” 

By contrast, reverse stress testing adopts a fundamentally different perspective. It starts with the identification of a critical failure outcome, such as a breach of regulatory capital requirements or a threat to the institution’s viability and then works backward to determine which combination of events or circumstances could plausibly lead to that outcome. This backward-looking construction is applied specifically to the geopolitical scenarios designed by the individual banks rather than a common macroeconomic shock. 

This methodological shift compels organisations to: 

• Examine vulnerabilities that may not be apparent under standard scenario analysis. 
• Challenge existing assumptions about risk exposures and resilience. 
• Consider complex and multi-factor events, including those that may not have historical precedent or that fall outside the scope of conventional risk models. 

By focusing on the pathways to failure, reverse stress testing allows supervisors to identify where and through which transmission channels, geopolitical shocks specific to a bank could translate into capital and/or liquidity constraints.  

Understanding geopolitical risk 

Geopolitical risk has become a defining feature of the global financial landscape, characterised by its complexity, unpredictability and far-reaching consequences. Recent years have witnessed a series of high-impact geopolitical events that underscore the challenges faced by financial institutions in identifying, measuring and managing these risks. Among the recent examples illustrating geopolitical complexity we can highlight: 

• Armed conflicts and regional instability: The ongoing war in Ukraine has demonstrated how armed conflict can disrupt global energy markets, trigger sanctions regimes and create significant volatility in commodity prices.  
• Sanctions and trade barriers: The imposition of sanctions on Russia and other jurisdictions have highlighted the operational and compliance challenges for banks. 
• Cybersecurity threats: State-sponsored cyberattacks, such as those targeting critical infrastructure in Europe and North America, have exposed vulnerabilities in operational resilience. 
• Supply chain disruptions: The COVID-19 pandemic and subsequent geopolitical tensions between major economies, such as trade disputes between the US and China, have led to persistent disruptions in global supply chains, impacting the real economy through inflationary pressures, credit defaults and increased operational risk. 

As such, geopolitical shocks propagate through multiple interconnected channels, including: 

• Financial markets: Heightened volatility, asset price declines and market fragmentation can erode capital buffers and undermine investor confidence. 
• Real economy: Sanctions, inflation and trade disruptions can increase credit risk, particularly in sectors and regions with concentrated exposures. 
• Operational resilience: Cyberattacks and disruptions to critical infrastructure can impair business continuity and expose banks to reputational and legal risks. 

The European Central Bank’s approach acknowledges that geopolitical shocks are frequently non-linear and capable of producing cascading effects across sectors and borders. By mandating reverse stress testing, supervisors aim to ensure that institutions are not only resilient to known risks but are also strategically prepared for unprecedented and complex scenarios. This proactive stance is essential for safeguarding financial stability in an era marked by heightened geopolitical uncertainty. 

Key components of the ECB's 2026 reverse geopolitical stress test 

Under the ECB's approach, banks will use their own scenarios, models and methodologies within a free-form reverse stress testing approach. Reporting will be limited and anchored in banks’ existing Internal Capital Adequacy Assessment Process (ICAAP), complemented by an additional ECB questionnaire covering, among other elements, the chosen scenarios, key triggers, solvency impact, funding and liquidity implications and mitigants and sensitivity analysis.  

Banks will also be required to assess non-financial risk impacts in addition to the capital depletion target and alongside liquidity and funding effects. They will also need to separately document the mitigating actions intended to address the adverse impacts identified.  

1. Scenario design and transmission mapping 

Banks must construct bespoke geopolitical scenarios that reflect their unique exposures, working backwards from an ECB-defined capital impact reference point using their ICAAP framework. Unlike macroeconomic stress tests, which often rely on standardised templates, geopolitical scenarios demand a deep understanding of internal vulnerabilities and external dependencies. Scenario design will be bank-specific and documented within the existing ICAAP, supplemented by a dedicated ECB questionnaire. This includes: 

• Identifying plausible geopolitical triggers (e.g., escalation of conflict, imposition of sanctions, cyberattacks). 
• Mapping how these triggers could propagate through financial, operational and strategic channels. 
• Assessing sectoral and country-specific vulnerabilities, such as concentrated exposures to high-risk regions or industries.  

2. Quantitative and qualitative impact assessment 

The impact assessment focuses primarily on capital and liquidity impacts, but must consider a broad range of possible transmission channels and risks: 

• Credit risk: Direct and indirect exposures to affected countries and sectors, default risk and concentration risk. 
• Market risk: Losses from asset revaluation (equities, bonds, FX, commodities), effectiveness of hedging strategies and correlation risks. 
• Liquidity and funding risk: Mandatory parallel assessment of liquidity and funding impact alongside capital depletion effects, including margin calls, funding cost increases and concentration of funding sources. 
• Operational risk: Cyberattacks, business continuity challenges, outsourcing risks and physical threats in conflict zones. 
• Governance and business model risk: Management of subsidiaries in risky countries, asset freezes and license withdrawals.  

3. Integration into ICAAP/ILAAP and governance 

Reverse stress testing is not a standalone exercise; it is explicitly aligned with the 2026 ICAAP and Internal Liquidity Adequacy Assessment Process (ILAAP) cycles. Banks may also use the ECB thematic exercise as their ICAAP reverse stress test for that year. This involves: 

• Updating risk appetite frameworks to reflect geopolitical risks. 
• Enhancing board-level oversight and ensuring that contingency plans and capital buffers are aligned with the outcomes of the reverse stress test. 
• Designing escalation protocols and response playbooks for hybrid threats.  

4. Supervisory dialogue and strategic implications 

The results of the reverse stress test are used for supervisory dialogue, risk culture assessment and contingency planning. Unlike the EBA's standardised approach, the ECB's methodology emphasises qualitative, bank-specific outcomes discussed bilaterally with supervisors, critical for internal resilience and strategic positioning. The output from the exercise will be provided in bank-specific reports with conclusions, and with the publication of aggregated system-wide results. 

Navigating through complexity  

Reverse stress testing for geopolitical risk is operationally demanding and complex for banks, especially for translating the geopolitical narratives into capital and liquidity outcomes that are then usable for ICAAP and dialogue with the supervisor.  

It requires: 

• Mapping the geopolitical triggers into quantifiable risks and transmission channels.  
• Sophisticated modelling of tail risks and second-order effects (e.g., inflation, sanctions, trade barriers). 
• Tight coordination across cross-functions, including risk, finance, treasury business lines and strategy to ensure accurate and internal consistency of scenario assumptions. 
• A culture of imagination and organisational maturity, as the challenge is not just analytical but also creative: envisioning scenarios that may have no historical precedent.   
• Strong senior management engagement to challenge scenario severity, plausibility and management response capacity.  

Many internal models are not designed to capture the full and granular transmission of geopolitical shocks across capital and liquidity dimensions. Banks must move beyond historical data and embrace forward-looking, judgment-based scenario building. This includes improving data quality, applying overlays to existing risk models and supporting macroprudential analytics (e.g., countercyclical capital buffer calibration).  

Geopolitical shocks often manifest through non-financial channels, such as cyberattacks or disruptions to critical infrastructure. Banks must evaluate their operational dependencies, map third-party risks and design response strategies for hybrid threats. This goes beyond financial modelling into the realm of crisis management and business continuity planning.  

A new paradigm of reverse stress test 

The ECB's 2026 stress test marks a targeted extension of existing supervisory practice into geopolitical risks. Rather than providing banks with predefined scenarios, the ECB will set predefined capital target and ask banks to create their own scenarios, such as disruptions from new tariffs, escalations in conflict zones or disruption to cross-border finding and payment channels.  

This approach underscores the importance of monitoring the potential impacts of geopolitical risks for the ECB, within the core supervisory toolkit for capital and liquidity assessment. For banks operating in regions with heightened exposure to geopolitical risks, including those with concentrated cross-border, trade-dependent or sanction-sensitive exposures, the challenge is particularly acute.  

As such, reverse geopolitical stress testing offers several strategic benefits: 

• Enhanced risk awareness: By identifying the scenarios that could lead to failure, banks gain a deeper understanding of their vulnerabilities and can take proactive measures to mitigate them. 
• Improved governance: The integration of reverse stress testing into ICAAP/ILAAP and board-level oversight strengthens the overall risk management framework. 
• Regulatory compliance: Meeting ECB expectations ensures that banks are not only compliant but also better prepared for supervisory scrutiny. 
• Resilience to radical uncertainty: By promoting scenario-thinking and forward-looking risk management, reverse stress testing prepares banks for radical uncertainty and non-linear shocks.  

Ultimately, the adoption of reverse geopolitical stress testing by the ECB signals a new standard in financial supervision; one that recognises the complexity, unpredictability and systemic importance of geopolitical risk. By challenging banks to identify their own points of failure and build resilience against extreme but plausible scenarios, supervisors are fostering a culture of strategic preparedness and adaptive risk management. 

As geopolitical tensions continue to shape the global financial system, reverse stress testing will become an indispensable tool for banks seeking to navigate an uncertain future. The lessons learned from the 2026 ECB exercise will not only inform regulatory practice but also set a benchmark for risk management in an era defined by volatility and change.