On 3 June 2025, the Centre for Economic Policy Research (CEPR) and the Leibniz Institute for Financial Research SAFE organized a web seminar on a special feature of the European Central Bank’s (ECB) May 2025 Financial Stability Review: “Risks to euro area financial stability from trade tensions”. The event was moderated by Florian Heider, Scientific Director of SAFE. Cosimo Pancaro, Team Lead in the Systemic Risk and Financial Institutions Division, and Stephan Fahr, Principal Financial Stability Expert, both at the ECB, shared their insights.
Impact on financial stability and the real economy
Stephan Fahr opened the session by describing the channels through which trade tensions affect financial stability. He outlined how increased trade policy uncertainty, particularly since 2021, has coincided with a surge in restrictive trade measures and a stagnation of global trade openness. He emphasized that while direct effects include exchange rate movements and asset price volatility, the more significant risks stem from trade policy uncertainty's impact on the real economy, by reducing corporate profits, increasing defaults, and lowering growth expectations.
Fahr also discussed the macro-financial implications of such uncertainty. While the primary impact of trade policy uncertainty manifests in the real economy - affecting output, inflation, and corporate solvency - there is a knock-on effect on systemic financial indicators. He pointed out that the ECB’s Systemic Risk Indicator (SRI) does reflect a modest increase in vulnerabilities. However, given their structural limitations, market-based measures like the CISS (Composite Indicator of Systemic Stress) are less responsive.
Large banking institutions tend to be more exposed
Cosimo Pancaro focused on the implications for the banking sector. He showed how heightened uncertainty negatively impacts banks' stock prices, credit default swap (CDS) spreads, and bond yields. The effects are cumulative: Lower profitability, increased provisioning, and reduced lending are all symptoms of sustained economic uncertainty. These effects are especially pronounced for banks with high exposures to trade-sensitive sectors, he points out: “Banks that are more reliant of extra EU trade tend to be affected more negatively by trade policy uncertainty.”
Pancaro noted that higher solvency ratios can serve as a buffer against these risks, but exposure levels vary across institutions, with larger institutions generally more exposed. He stressed the need for proactive risk management strategies, including portfolio diversification and enhanced monitoring of vulnerable sectors.
Concluding the event, the speakers called for more proactive risk management. Diversification of exposures, updated stress testing frameworks, and close monitoring of emerging vulnerabilities were recommended to ensure resilience in a more fragmented and uncertain global trade environment. In an era of heightened geopolitical tension and uncertain trade policy, they called for both regulators and financial institutions to stay vigilant, diversify risks, and prepare for shocks that may test the resilience of the euro area’s financial system.
