Integrating contagion risk into the 2025 EU-wide stress test: a system-wide analysis with amplification effects between banks and non-banks

Overview

The 2025 EU-wide stress test now includes contagion risk, assessing the interconnectedness between banks, investment funds, and insurance corporations. This approach highlights the amplification effects of financial shocks across sectors.

Key Insights

• CET1 Ratio Depletion: The stress test predicts an average CET1 ratio depletion of 29 basis points, with first-round effects increasing by 12%.
• Sector Impact: Investment funds, particularly equity funds, are most affected under the EBA’s adverse scenario.
• Hedging Capabilities: Banks with less sophisticated hedging strategies are significantly impacted.
• System-wide Perspective: Emphasizes the importance of capturing spillover effects within and across financial sectors.

Why It Matters

This analysis is crucial for understanding the systemic risks in the financial sector, particularly for investment funds and banks.

Actionable Implications

• Banks: Enhance hedging strategies to mitigate contagion risks.
• Regulators: Consider system-wide impacts in stress testing frameworks.
• Investment Funds: Prepare for potential losses under adverse scenarios.