Europe's Banks Face Growing Risk Test, EBA warns

European banks have entered the second half of the year from a position of strength, but an increasingly volatile geopolitical and economic backdrop is creating new risks that could test the resilience built up since the global financial crisis, according to the European Banking Authority's latest Risk Assessment Report.

The regulator said EU and European Economic Area banks continue to expand their balance sheets, maintain strong capital positions and report healthy profitability despite heightened uncertainty.

Lending to households and businesses grew by 2.7% during 2025, while return on equity remains above 10%, supported by resilient net interest income and stable fee generation.

However, the EBA warned that a combination of geopolitical tensions, cyber threats, climate risks and growing links with non-bank financial institutions is reshaping the industry's risk landscape.

One of the regulator's principal concerns is the indirect impact of conflict in the Middle East.

Although direct exposures to the region remain limited, the report warns that higher energy prices, inflationary pressures and supply chain disruption could significantly weaken asset quality, particularly among energy-intensive industries.

Manufacturing, utilities, transport and heavy industry are identified as sectors most vulnerable to sustained increases in energy costs.

The report notes that banks have already increased provisions in some areas as geopolitical uncertainty has intensified, even though overall non-performing loan ratios remain close to historic lows.

Commercial real estate, small and medium-sized enterprises and consumer credit continue to represent the most vulnerable lending segments, while country-level differences remain pronounced.

The EBA also highlighted the rapid growth of non-bank financial institutions and private credit as an emerging source of systemic risk.

Exposures to non-bank financial institutions increased significantly during 2025 and now account for around 10% of total banking assets.

While direct private credit exposures remain relatively limited, the regulator warned that interconnectedness between banks, private credit funds and asset managers is increasing, creating additional channels through which market stress could spread.

The report echoes concerns raised in recent months by the Financial Stability Board and Bank for International Settlements, both of which have warned that rapid expansion of private credit, particularly financing linked to artificial intelligence infrastructure and data centers, could amplify risks if valuations deteriorate or economic conditions weaken.

Technology risk also features prominently in the assessment. The EBA said advances in frontier artificial intelligence models capable of identifying and exploiting software vulnerabilities are increasing cyber risks for financial institutions.

Although reported cyberattacks have not risen materially, the regulator warned that geopolitical tensions are increasing both cyber and data security threats, requiring banks to strengthen operational resilience as AI capabilities continue to evolve.

Climate risk remains another area where supervisory expectations continue to rise.

The report concludes that European banks are generally leading global peers in integrating climate considerations into governance, risk management and strategic planning.

Most institutions have now established quantitative climate targets and strengthened board oversight, although implementation continues to vary considerably between firms.

Despite these risks, the EBA expects lending activity to continue expanding over the coming years, with banks forecasting stronger cross-border lending across the European Union alongside increased financing for infrastructure, defense, technology and energy transition projects.

The regulator cautioned, however, that these growth expectations may prove optimistic if geopolitical tensions persist or market volatility disrupts funding conditions.

Funding remains broadly stable, with deposits continuing to provide the cornerstone of bank balance sheets.

Nevertheless, competition for customer deposits is expected to intensify while institutions remain vulnerable to sudden repricing in wholesale funding markets should investor sentiment deteriorate.

Overall, the report paints the picture of a banking sector that has become considerably more resilient but now faces a broader and more interconnected set of risks than in previous years.