While past stress tests for European banks examined the industry’s vulnerability to traditional economic and financial shocks, this year’s exercise will test its resilience to Trump — making it tougher to forecast the results, according to Morningstar DBRS Inc.
On Jan. 20, the European Banking Authority (EBA) launched its 2025 stress test for the banking sector, which will assess the industry’s resiliency under both baseline and adverse scenarios over the period from 2025 to 2027.
In a new report, DBRS noted that the stress test’s adverse scenario assumes that GDP in the European Union drops by 6.3% between 2025 and 2027, while the baseline scenario has output rising by 1.5% over the period.
“Under the adverse scenario, the EU ends in a substantial recession in 2025 and 2026, with some economic recovery in 2027,” DBRS said.
The test also assumes that real estate prices drop by 29.5% over the three-year period, and that equity prices face severe declines, dropping by 50% in 2025, 46% in 2026, and 42% in 2027, the report noted.
Compared with the previous stress test in 2023, the upcoming exercise assumes less inflation and interest rate pressure, DBRS said. Instead, it examines economic turmoil that is driven “by geopolitical tensions and an escalation of conflicts” while incorporating major shocks to trade and significant disruptions to supply chains — and the resulting fallout of higher energy and commodity prices and lower equities, residential and commercial real estate prices.
According to DBRS, the European banks head into this year’s stress test in a stronger financial position, and better able to cope with an adverse scenario, than they were in the previous test. However, given that the drivers of disruption are new and uncertain, it’s difficult to forecast how individual banks will fare.
“The severity of the assumptions related to the escalation of geopolitical conflicts makes it challenging to anticipate any results compared with previous stress tests,” it said. “As a result, there could be some unexpected findings compared with the performance of banks in previous exercises.”
Nevertheless, the report suggested that banks with higher exposures to certain sectors, including commercial real estate, oil and gas, or manufacturing, “could be more affected by the assumptions in the adverse scenario.”
The results of the test will be published in early August.