Strong Capital, New Pressures as European Banks Navigate Geopolitical Uncertainty

Key Takeaways

• Strong Starting Position: EU and EEA banks remain well-capitalized, with a CET1 ratio of 16.3% and solid profitability heading into 2026.
• Exposure Is Limited but Not Irrelevant: Direct exposure to the Middle East stands at €132 billion, less than 0.5% of total assets.
• Second-Order Risks Are the Real Story: Energy prices, inflation, and supply chain disruptions pose the bigger threat.
• Asset Quality Still Improving: NPL ratios held at 1.8%, while Stage 2 loans declined to 9.1%.
• Liquidity Remains a Strength: LCR rose to 163.1%, supported by growing customer deposits.

Deep Dive

Europe’s banking sector is stepping into a more volatile geopolitical landscape with a steady footing, according to new data released Monday by the European Banking Authority.

The regulator’s Q4 2025 Risk Dashboard paints a picture of an industry that, at least for now, remains well-capitalized, liquid, and operationally sound, even as renewed conflict in the Middle East introduces fresh uncertainty into the global economic outlook.

That sense of stability is not accidental. It reflects years of post-crisis regulatory tightening and capital build-up. But the report makes clear that resilience will soon be tested not by direct exposures, which remain limited, but by the secondary effects of geopolitical disruption.

Limited Exposure, Broader Risks

European banks’ direct exposure to counterparties in the Middle East totaled €132 billion at the end of 2025. That figure includes roughly €47 billion in lending to financial institutions and €33 billion to non-financial corporates.

In isolation, the exposure is modest, less than 0.5% of total banking assets across the EU and EEA. But the EBA flags a more complex risk picture emerging beneath the surface.

Escalating tensions could ripple through the global economy via higher energy prices, renewed inflationary pressures, and disruptions to supply chains. Those second-order effects are expected to hit energy-intensive industries hardest, including transport, construction, and segments of manufacturing.

For risk and resilience leaders, this is the familiar shift from localized exposure to systemic stress, where the real threat is not where capital is deployed, but how interconnected shocks propagate.

Capital and Profitability Provide a Buffer

Against that backdrop, banks’ core financial metrics remain a key line of defense.

Risk-weighted assets rose modestly by just over 1% in 2025 to €10.2 trillion, while the common equity tier 1 ratio held steady at 16.3%. Even under the transitional framework tied to the latest regulatory reforms, that level of capitalization signals significant loss-absorbing capacity.

Profitability has also remained intact. Return on equity came in at 10.4%, only slightly below the 10.5% recorded a year earlier. Meanwhile, net interest margins, which had been trending downward through much of 2025, showed signs of stabilizing at 1.6% in the fourth quarter, suggesting that margin compression may have reached its floor.

Still, there are early signs of pressure building. The cost-to-income ratio climbed to its highest level since early 2023, reflecting rising operating costs and seasonal factors. For banks, maintaining profitability in a higher-cost, lower-growth environment will be an increasingly delicate balancing act.

Asset Quality Holds, For Now

Credit quality remains another area of relative strength.

Non-performing loans edged down to €370 billion, keeping the overall NPL ratio stable at 1.8%. At the same time, Stage 2 loans, often viewed as an early warning indicator of deteriorating credit conditions, declined to 9.1% from 9.3% in the previous quarter.

Taken together, those figures suggest that asset quality has not yet begun to deteriorate in response to geopolitical stress. But the EBA’s framing is cautious. Improvements seen at the end of 2025 may precede, rather than preclude, a shift if macroeconomic conditions worsen.

Liquidity and Funding Strengthen

Liquidity remains a clear bright spot.

The liquidity coverage ratio rose to 163.1%, with more than 80% of banks reporting levels above 140%. The net stable funding ratio also improved to 126.9%, while the loans-to-deposits ratio continued its downward trend, falling to 104.8%.

That shift reflects a continued reliance on customer deposits, which grew notably in the final quarter of the year. Household deposits increased by 1.8%, while deposits from non-financial corporates rose by 3.6%, offsetting declines in funding from other financial institutions and central banks.

In practical terms, this strengthens banks’ ability to weather short-term shocks and reduces reliance on more volatile funding sources—an important buffer in uncertain conditions.

New Rules, Gradual Adjustment

Alongside the Risk Dashboard, the EBA also introduced its new CRR3 and CRD6 dashboard, offering a forward-looking view of how regulatory changes will shape capital positions through 2030.

Under the fully implemented framework, banks’ average CET1 ratio is projected to decline slightly to around 15.3%. The change reflects a 4.7% increase in minimum Tier 1 capital requirements as the so-called “output floor” is phased in.

Importantly, the transition appears manageable. Only two institutions were constrained by the output floor at the end of 2025, but that number is expected to rise to 33 under full implementation. Even so, no capital shortfalls are projected before 2030.

When they do emerge, the shortfalls are expected to be modest at first (around €424.8 million) before rising to €12.7 billion once the framework is fully in place. The timeline, regulators note, gives banks ample room to adjust.

A Sector Built for Shock, Facing New Tests

European banks are entering this latest period of geopolitical uncertainty from a position of strength (well-capitalized, liquid, and supported by relatively strong asset quality). But the nature of the risks ahead is less about direct exposures and more about systemic spillovers.

The challenge will be less about identifying obvious vulnerabilities and more about navigating interconnected ones, where energy markets, inflation dynamics, and supply chains converge.

The balance sheets may be strong. The question now is how they hold up under a different kind of strain.

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