MILAN, Italy: European banks are well-positioned to absorb a significant economic downturn triggered by geopolitical conflict and a global trade war, the European Banking Authority (EBA) said, following the release of its latest sector-wide stress test.

The 2024 assessment simulated how 64 banks across the EU, including 51 from the eurozone, would fare in a three-year recession marked by surging energy prices, disrupted trade flows, and shrinking investment. None of the banks breached core capital requirements under the adverse scenario, and only one fell short of the minimum leverage ratio.

"The results indicate that the EU banking system could withstand a severe but plausible macroeconomic scenario, reflecting the resilience built up by banks in recent years," the EBA said in a statement. It urged lenders to maintain adequate capital buffers.

The stress test was designed to measure banks' vulnerability to a scenario involving escalating geopolitical tensions, U.S. trade tariffs, and instability in the Middle East. The EBA projected that these shocks would lead to a 6.3 percent cumulative contraction in EU GDP between 2025 and 2027.

The simulation predicted total losses of 547 billion euros across the tested banks, higher than the 496 billion euros projected in the previous 2023 stress test. While the results varied by institution and country, the EBA concluded that the overall financial system remains robust enough to avoid systemic failure.

In terms of capital reserves, the average Common Equity Tier 1 (CET1) ratio among participating banks would drop by 3.7 percentage points—from 15.8 percent in 2023 to 12.1 percent by 2027—under the adverse scenario. This decline reflects the cumulative effect of credit losses, lower income, and increased risk-weighted assets.

The most significant capital hits were observed among banks operating in Ireland, Denmark, France, Germany, and Belgium. On an individual level, Germany's Landesbank Baden-Württemberg and two other regional German lenders saw the steepest projected losses, alongside France's Crédit Agricole and La Banque Postale.

For 17 banks in the sample, the stress scenario would lead to restrictions or adjustments to dividend or bonus payments for at least one year during the test period.

The EBA also noted that some of the risk factors in its model have already begun to materialize, including rising protectionism and geopolitical instability. The findings are particularly relevant as policymakers and regulators weigh the implications of prolonged global uncertainty and possible further economic shocks.

Stress tests became a formal regulatory tool following the 2008 global financial crisis, which exposed widespread weaknesses in the banking sector and led to expensive taxpayer-funded bailouts. While there is no pass/fail threshold in the EBA's assessment, the results help supervisors evaluate bank-specific capital needs and feed into the broader regulatory framework under what's known as "Pillar 2" guidance.