The European banking system remained well capitalised and liquid through 2024, but early signs of asset quality deterioration emerged, the European Central Bank warned on 15 July 2025. Claudia Buch, chair of the ECB’s supervisory board, stated that although the sector has shown resilience, recent tariff announcements and heightened geopolitical risk introduced growing uncertainty that could challenge balance sheets over time.

According to Buch, significant European institutions ended 2024 with a common equity tier 1 (CET1) ratio of 15.9% and a leverage ratio of 5.9%. Liquidity buffers stayed largely stable. Profitability also remained strong, with an average return on equity of 9.9% in 2024–a marked improvement from the 5.5% average during the prolonged low interest rate period between mid-2015 and mid-2022. Preliminary data for Q1 2025 indicated that both profitability and funding conditions remained broadly stable.

However, the ECB noted an uptick in indicators of deteriorating asset quality. The proportion of stage 2 loans–a proxy for increased credit risk–rose to nearly 10% by the end of 2024, up from 8.4% in 2020. The ratio of non-performing loans held steady at around 2%, but vulnerabilities were concentrated in commercial real estate-backed exposures.

Tariff tensions raise long-term uncertainties

The ECB acknowledged that the initial market reaction to new tariff announcements was short-lived, with volatility and margin calls spiking and funding spreads widening temporarily, although remaining below historical peaks. Nevertheless, Buch cautioned that the full impact on bank balance sheets would become evident only over time, particularly if trade flows slow and corporate financial health weakens.

The ECB highlighted that while asset quality had not yet deteriorated materially, banks might face rising credit risk and provisioning needs in the future. The current European stress test framework already includes scenarios driven by geopolitical tensions and higher tariffs, designed to assess the banking sector’s resilience to a worsening macroeconomic environment. Banks were urged to assess their clients’ exposures to tariffs and disruptions in global value chains.

Supervisory focus

To mitigate emerging risks, the ECB reinforced three supervisory priorities. First, banks must enhance their capacity to withstand geopolitical shocks. The ECB cited multiple supervisory initiatives addressing banks’ responses to geopolitical risk, with a 2026 thematic stress test planned to evaluate firm-specific vulnerability scenarios.

Second, banks were urged to address long-standing deficiencies in internal information systems. The ECB stated that reliable data systems were essential for sound decision-making and risk management, as well as for lowering regulatory reporting costs.

Third, the ECB called for improvements in digitalisation strategies. Banks faced growing competition from non-bank financial entities, particularly in payment services and crypto-assets. These developments, coupled with diverging international standards and increased exposure to private market funds, have added layers of complexity that may obstruct effective risk management.

Banking union key to long-term stability

Looking ahead, the ECB reiterated that completing the banking union and deepening the single market were essential for long-term growth and financial stability. The European Parliament’s recent resolution calling for the completion of the union–including the establishment of a European deposit insurance scheme–was welcomed.

The ECB argued that regulatory harmonisation, particularly in areas such as bank governance, accounting and insolvency legislation, would lower fragmentation and enable the development of pan-European banking models. Buch noted that although the ECB had harmonised certain options and discretions within its supervisory remit, national legal differences continued to hinder market integration and complicate supervision.

The ECB concluded that maintaining resilience while simplifying frameworks would best support the sector’s ability to finance the real economy, particularly in a context of evolving risks and geopolitical uncertainty.