The European Central Bank published its May 2025 Financial Stability Review, warning that a sharp rise in uncertainty around global trade policy and broader geopolitical shifts has driven spikes in market volatility and increased downside risks to economic growth. The review highlights vulnerabilities from stretched asset valuations and low liquidity buffers in parts of the non-bank sector, and flags that escalating trade tensions could translate into higher credit risk for euro area banks and non-banks while pressures on government finances may rise alongside higher defence spending. An early April global sell-off tightened financial conditions, and although risky assets had recovered initial losses by mid-May, markets remained highly sensitive to tariff-related news. Equity markets were described as particularly exposed to sudden adjustments given still-high valuations and concerns over risk concentrations, while heightened volatility could reveal euro area non-banks’ liquidity and leverage weaknesses and amplify market shocks. For the real economy, improved corporate and household balance sheets face headwinds in an open euro area economy, with trade frictions potentially affecting firms reliant on foreign trade and spilling over to households via layoffs. On the sovereign side, debt-to-GDP ratios have fallen from pandemic peaks but fiscal fundamentals remain fragile in some countries, and increased defence spending may boost growth if productive but could raise issuance needs at a time of higher funding costs, compounding pressures from other structural challenges. Against this backdrop, the review calls on macroprudential authorities to maintain existing capital buffer requirements and borrower-based measures to support sound lending standards, and argues for a comprehensive set of policy measures to strengthen the resilience of non-bank financial intermediation and support euro area capital markets integration.

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