The European Central Bank published its May 2025 Financial Stability Review, concluding that the euro area financial system remains resilient but that a sharp rise in geopolitical and policy uncertainty, triggered by US tariff announcements, has materially increased downside risks. It identifies three main channels of vulnerability: disorderly corrections from still-stretched asset valuations amplified by fragilities in non-bank finance, trade tensions translating into corporate and household credit risks for banks and non-banks, and renewed pressures on some sovereigns as weaker growth coincides with higher spending needs. The Review notes that markets sold off sharply after higher-than-expected US import tariffs announced on 2 April 2025 and then rebounded after a 90-day tariff pause for most countries, while remaining highly sensitive to trade-related news. It points to persistent valuation and concentration risks in global equities, corporate bond spreads that appear low relative to elevated uncertainty, and signs that open-ended corporate bond funds may be unprepared for severe liquidity stress. In the non-bank sector, variation margin calls following early-April tariff announcements exceeded EUR 60 billion, equivalent on average to 3.6% of cash buffers for the non-bank financial intermediation sector and 5.4% for pension funds. For banks, profitability stayed strong (return on equity above 9% in 2024) and buffers remained robust (Common Equity Tier 1 ratio of 15.4% and liquidity coverage ratio of 159%), but provisioning needs are expected to rise as macro-financial headwinds and trade uncertainty weigh on the credit outlook. On policy, the Review argues for a comprehensive macroprudential response to non-bank vulnerabilities, including measures addressing liquidity mismatch in open-ended funds, closer monitoring and constraints on leverage, stronger liquidity preparedness for margin and collateral calls, and enhanced EU-wide supervisory coordination to limit arbitrage. It also notes the postponement of the EU application date for the Fundamental Review of the Trading Book to 1 January 2026 and that the European Commission is considering further adjustments to the EU market risk rules to maintain a level playing field, with the ECB indicating it is ready to contribute to consultations.
European Central Bank 2025-05-21
European Central Bank highlights US tariff shock and non-bank liquidity vulnerabilities in its May 2025 Financial Stability Review
The European Central Bank's May 2025 Financial Stability Review highlights the euro area's resilience amid geopolitical and policy uncertainty from US tariff announcements, identifying vulnerabilities in asset valuations, credit risks, and sovereign pressures. It calls for a macroprudential response to non-bank vulnerabilities, including liquidity mismatch measures and enhanced EU-wide supervisory coordination. It also notes the postponement of the EU application date for the Fundamental Review of the Trading Book to 2026 and potential adjustments to EU market risk rules.