Document Purpose: Reverse stress test scenario specifications for European banks
Regulatory Alignment: EBA GL/2018/04, CRR3/CRD6, ECB SSM
Analysis Source: MCP-HEED Strategic Review November 2025
EXECUTIVE SUMMARY
This framework translates six CRITICAL risks (scores ≥8.0/10) into four ECB-compliant reverse stress test scenarios designed to identify capital adequacy failure points. Each scenario works backward from CET1 regulatory breach thresholds, incorporating CRR3/CRD6 capital requirements effective January 2025.
Regulatory Compliance: EBA GL/2018/04, ECB SSM, CRR3/CRD6 aligned. Prepared for ECB 2026 geopolitical stress test. All scenarios include historical calibration, probability estimates (8-22% / 36 months), and SREP-ready recovery frameworks.
Scenario | Primary Risk | CET1 Depletion | Probability | Severity |
RST-2025-GEO-01 | Geopolitical Conflict (9.5/10) | -485 bps | 18% | Recoverable |
RST-2025-GEOECON-02 | Geoeconomic Fragmentation (9.0/10) | -580 bps | 22% | Critical |
RST-2025-SHADOW-03 | Shadow Banking Crisis (8.5/10) | -455 bps + LCR | 15% | Dual failure |
RST-2025-COMPOUND-04 | Multi-Risk Compound | -650 bps | 8% | Resolution risk |
METHODOLOGY
Reverse Stress Testing: Identifies event combinations rendering business models non-viable by breaching regulatory capital (typically 8.5-12% CET1 = Pillar 1 + P2R + CBR).
Risk Source: MCP-HEED November 2025 identifies geopolitical conflict (#1 global risk), US-EU tariffs at Smoot-Hawley levels, IMF private credit warnings (64% managers facing redemptions), China real estate crisis (-10% prices, 48M incomplete homes).
CRR3/CRD6: All calculations use Capital Requirements Regulation III effective 01-January-2025.
SCENARIO 1: GEOPOLITICAL CONFLICT ESCALATION CASCADE
RST-2025-GEO-01 | Probability: 18% over 36 months
Failure Point: CET1 ratio breaches 8.5% minimum TSCR through combined credit losses, trading book revaluation, and operational disruption.
Scenario Narrative: Taiwan Strait military crisis triggers simultaneously with Ukraine conflict escalation and Middle East expansion, creating "tri-polar geopolitical stress." Asian equity indices -25%, European -18%, US -15%. Credit spreads widen dramatically: IG corporate +175bps, HY +450bps, EM sovereign +550bps. Supply chain disruptions intensify (40% semiconductor production affected), energy security crisis deepens (European gas +180%), food commodities spike +45% YoY. Banking sector experiences combined credit deterioration, trading losses, and operational disruption (cyber incidents +300%).
Impact Component | T+36 Months | CET1 Impact |
Corporate lending defaults | 7.5% NPL ratio | -175 bps |
Commercial real estate | 12.0% NPL ratio | -95 bps |
Trade finance losses | 8.0% NPL ratio | -40 bps |
Sovereign exposure MTM | -22% | -60 bps |
Equity portfolio revaluation | -18% | -45 bps |
Fixed income trading | +250bps spreads | -35 bps |
Cyber incidents + disruption | Major breach | -45 bps |
NII/Fee income decline | -25%/-40% | -90 bps |
Total CET1 Depletion |
| -485 bps |
Pro Forma CET1 | From 13.5% → 9.05% | Near breach |
Most Exposed Portfolios:
Trade Finance (€18B exposure): 8.0% loss rate = -40 bps impact
Emerging Market Sovereign Bonds (€12B): -22% MTM = -60 bps
Technology Sector Lending (€25B): 6.5% loss rate = -45 bps
European Energy-Intensive Industrials (€15B): 5.5% loss rate = -25 bps
Recovery Actions: Phase 1 (T+0-6): Dividend suspension (+90 bps preservation), risk appetite tightening (+40 bps), derivative hedging (+35 bps). Phase 2 (T+6-18): Strategic asset disposal (+145 bps), cost reduction (+60 bps), portfolio runoff (+120 bps). Recovery viability: HIGH (85% success probability with Phase 1-2 actions).
Historical Calibration: 70-75% of 2008 GFC severity with different transmission (geopolitical vs financial). 2022 Ukraine invasion, 2020 COVID March, 1973 Oil Crisis precedents validate parameter ranges.
SCENARIO 2: GEOECONOMIC FRAGMENTATION CASCADE
RST-2025-GEOECON-02 | Probability: 22% over 36 months
Failure Point: CET1 breaches 9.0% minimum through corporate credit deterioration and revenue compression as trade fragmentation destroys multinational banking profitability.
Scenario Narrative: US imposes 25% tariffs on EU manufactured goods, 15% on agricultural imports. EU retaliates with 22% on US tech, financial services restrictions. Total effective tariff rates 35-45% exceed Smoot-Hawley levels. Exporters experience 15-25% margin compression, supply chain reconfiguration costs €2.8B, working capital requirements +30%. First wave corporate distress: UK bankruptcies +25% YoY, US +18% YoY. Banking sector experiences systematic deterioration: IG→HY migration +40%, HY→Distressed +65%, actual defaults 6.5% manufacturing. Transaction banking revenue collapses -55% as bilateral trade -40%.
Impact Component | T+36 Months | CET1 Impact |
EU corporate manufacturing | 7.2% NPL | -145 bps |
US corporate manufacturing | 6.5% NPL | -110 bps |
Cross-border lending surge | 8.5% NPL | -85 bps |
CRE indirect exposure | 6.8% NPL | -50 bps |
Transaction banking collapse | -55% | +65 bps offset lost |
Capital markets fees | -45% | +45 bps offset lost |
Net interest income | -18% | +40 bps offset lost |
Compliance/restructuring | +€520M | -35 bps |
Total CET1 Depletion |
| -580 bps |
Pro Forma CET1 | From 12.8% → 7.2% | BREACH |
Most Exposed Portfolios:
EU/US Manufacturing Exposures: Combined -255 bps impact
Cross-border Corporate Lending: 8.5% NPL = -85 bps
Transaction Banking Business: -55% revenue = strategic viability question
Recovery Actions: Phase 1-2 achieve +470 bps recovery (dividend suspension, business restructuring, portfolio runoff). Phase 3 requires external capital raise (€6.5B rights issue +180 bps) or strategic merger. Recovery viability: MODERATE (65%) - requires fundamental business model pivot from cross-border to domestic focus.
Historical Calibration: 1930s Smoot-Hawley Tariff Act and Great Depression provide primary analogue. ECB President Lagarde confirmed November 2025 that current US-EU tariffs match these historical levels.
SCENARIO 3: SHADOW BANKING LIQUIDITY CRISIS
RST-2025-SHADOW-03 | Probability: 15% over 36 months
Failure Point: DUAL FAILURE - CET1 breaches 8.5% minimum while LCR simultaneously falls to 95% (below 100% requirement), triggering supervisory liquidity intervention.
Scenario Narrative: Technology sector correction accelerates as MIT 95% AI investment failure rate becomes public. AI-focused private credit funds experience sudden NAV decline -12% in single quarter. Three large funds (€8B, €12B, €15B AUM) gate redemptions to 5% quarterly. Redemption cascade: 72% of managers report increased requests. Secondary loan market collapses: bid-ask 8-15 points vs normal 1-2, volumes -75%. Forced sales at 75-80% fair value. Banking sector transmission through: €4.2B fund financing lines drawn fully, €3.8B prime brokerage margin inadequacy, HY spreads +380bps sympathy, wholesale funding -45% capacity.
Component | Impact | Result |
Fund facility credit losses | 12.5% cumulative | -140 bps |
Prime brokerage CVA/DVA | -€680M | -60 bps |
HY portfolio MTM | -18% | -85 bps |
AFS forced realization | -€2.2B | -95 bps |
Fee income collapse | -60% | +55 bps lost |
Funding cost surge | +165bps | -30 bps |
Total CET1 Impact |
| -455 bps |
CET1 Position | From 13.2% → 8.65% | Near breach |
HQLA decline | €45B → €35B | -22% |
Net cash outflows rise | €31B → €37B | +19% |
LCR Ratio | From 145% → 95% | BREACH |
Recovery Actions: Phase 1 Liquidity (T+0-3): Central bank access (+15% LCR), asset sales (+8% LCR), covered bond issuance (+5% LCR). Phase 2 Capital (T+3-12): Capital conservation (+90 bps), risk reduction (+80 bps), portfolio restructuring (+80 bps). Phase 3 Structural (T+12-36): Complete exit from fund services and prime brokerage, funding transformation to deposits, €4.5B capital raise (+125 bps). Recovery viability: MODERATE (70%) - requires business line exit.
Historical Calibration: 2008 GFC structured finance collapse, 2020 March COVID credit fund stress, 1998 LTCM crisis provide precedents. IMF October 2025 systemic warnings validate scenario plausibility.
SCENARIO 4: COMPOUND MULTI-RISK CRISIS
RST-2025-COMPOUND-04 | Probability: 8% over 36 months
Failure Point: CET1 breaches 7.5% (Pillar 1 + P2R minimum before buffers) through synchronized activation of geopolitical conflict, trade fragmentation, and shadow banking stress creating 1.35x amplification factor.
Scenario Narrative: Taiwan Strait military crisis occurs simultaneously with US-EU tariff escalation to 40%+ levels while private credit funds face combined sector stress. Each crisis reinforces others: Semiconductor disruption compounds tech tariff stress → Corporate defaults 2.5x baseline. Private credit redemptions force sales into geopolitically-stressed markets → Spreads +650bps vs +450bps standalone. Trade finance collapses from both conflict AND tariffs → NPL 11.5% vs 8.0-8.5% individual scenarios.
Amplification Mechanism | Factor | Impact | Basis Points |
Base weighted impact (scenarios 1-3) | Linear summation |
| -507 bps |
Correlation breakdown | Diversification fails (0.40→0.82) |
| +95 bps |
Policy response limitation | Constrained monetary/fiscal |
| +48 bps |
Market liquidity premium | Forced sale illiquidity |
| +42 bps |
Amplification Factor |
| 1.35x |
|
Total CET1 Depletion |
|
| -650 bps |
Pro Forma CET1 | From 14.0% → 7.50% | CRITICAL |
|
Compound Transmission Examples:
Geopolitical → Geoeconomic: Military conflicts drive sanctions → Accelerate trade fragmentation (8.0/10 strength)
Geoeconomic → Shadow Banking: Trade war margin compression → Corporate distress → Private credit underperformance → Redemptions (7.5/10 strength)
Correlation Breakdown: EM sovereign bonds normally -0.25 correlation to DM equities → Shifts to +0.75 in compound stress
Recovery Actions: Phase 1-2 achieve +470 bps but insufficient. Phase 3 requires €7.5B+ external capital within 30 days OR faces Single Resolution Board (SRB) referral for resolution assessment. Recovery viability: LOW (45%) - technical insolvency territory.
Regulatory Response: Mandatory capital restoration plan within 2 weeks, enhanced daily/weekly reporting, assessment of Article 104 additional own funds requirement, potential SRB referral if capital raise unsuccessful.
Historical Calibration: 1930s Great Depression (geopolitical + trade + financial compound) represents closest severity analogue. Scenario models 75-80% of 1930s peak stress adapted to modern financial system structure.
SCENARIO PRIORITIZATION & IMPLEMENTATION
Priority 1: Scenario 2 - Geoeconomic Fragmentation (22% probability, -580bps, already active)
Priority 2: Scenario 1 - Geopolitical Conflict (18% probability, highest risk score 9.5/10)
Priority 3: Scenario 3 - Shadow Banking Crisis (15% probability, dual capital-liquidity failure)
Priority 4: Scenario 4 - Compound Crisis (8% probability, catastrophic severity)
Implementation: Integrate into Q1 2026 ICAAP/ILAAP cycles and ECB 2026 reverse stress test preparation.
MANDATORY DISCLAIMER: This framework provides analytical scenarios for risk management and regulatory compliance preparation. It does NOT constitute financial recommendations, regulatory guidance, or official supervisory expectations from ECB/EBA. Scenarios are hypothetical and designed to identify vulnerabilities, not predict outcomes. Institutions should consult qualified legal, regulatory, and financial advisors before implementing frameworks or making business decisions. MCP-HEED assumes no liability for regulatory compliance determinations or capital adequacy assessments.