The financial system is under stress according to the ECB, which in its Financial Stability Report sounds the alarm, estimating that “financial stability has become more vulnerable as the geo-economic shock evolves.” The outlook for financial stability in the eurozone is shaped by geo-economic tensions and disruptions in energy supply, while the intensity and duration of the impacts remain uncertain, according to the May 2026 Financial Stability Report published today by the European Central Bank.
“Today’s energy supply shock creates upside risks to inflation and downside risks to economic growth,” said ECB Vice President Luis de Guindos. “It could also increase market volatility and make debt servicing more difficult, as funding costs rise in an environment of weaker economic growth.”
The global financial system and the real economy had shown remarkable resilience when entering 2026, despite a series of successive shocks. However, according to the Report, this resilience is now being tested by a major geo-economic shock caused by the war in the Middle East. Intense geo-economic pressure is reinforced by continuing uncertainty around global trade and international cooperation. Meanwhile, cybersecurity risks and hybrid threats against critical infrastructure are increasing within this complex geopolitical environment.
ECB: Financial markets adjust to geo-economic pressures
Financial markets are adjusting to geo-economic pressures and energy supply disruptions. Initial market adjustments proved short-lived, resulting in equity valuations remaining high in historical terms. At the same time, risk premiums on corporate bonds remain compressed internationally, making valuations vulnerable to the unusually high level of geopolitical and policy uncertainty. There is therefore significant risk of deteriorating investment climate, as negative risks related to geopolitical, fiscal and macro-financial developments appear to be underestimated. Fiscal expansion in a difficult geo-economic environment could further burden public finances of some over-indebted eurozone countries and lead to sovereign risk repricing.
Non-bank entities have generally remained resilient to the Middle East war, but face risks from a broad market retreat. Specifically, the combination of low liquidity buffers, high portfolio valuations and concentrated exposures on their balance sheets increases the risk of forced asset sales, which could amplify market pressure. While not constituting a systemic risk per se for the eurozone, opaque and interconnected private markets require close monitoring due to transmission risks, particularly from the United States.
Eurozone banks have managed recent waves of uncertainty satisfactorily, supported by strong profitability and adequate capital and liquidity buffers. However, the increased importance of non-bank sources in their funding could expose them to liquidity and funding risks if market conditions become more unstable. Meanwhile, bank asset quality could deteriorate if macro-financial conditions worsen significantly due to the Middle East war, although banks’ direct exposures to the region are limited and concentrated in a few banks. Specifically, a prolonged shock could cause significant secondary effects, mainly for eurozone companies operating in sectors sensitive simultaneously to trade, energy and interest rates, with potential impacts on households through deteriorating labor market conditions or rising cost of living.
In today’s exceptionally uncertain geo-economic environment, maintaining and strengthening the resilience of the financial system is critically important. To this end, macroprudential authorities should maintain existing capital buffer requirements and borrower-based measures to ensure bank resilience and adherence to sound lending standards. Additionally, persistent vulnerabilities in terms of liquidity and leverage in the non-bank financial intermediation sector require a comprehensive policy response. Finally, accelerating progress toward the EU Savings and Investment Union will be crucial for supporting growth and competitiveness while safeguarding financial stability.
