In December 2025, the European Central Bank announced a new supervisory initiative: a geopolitical risk reverse stress test covering 110 directly supervised banks, to be conducted throughout 2026. Each institution will be required to identify scenarios that could deplete their Common Equity Tier 1 capital by at least 300 basis points, focusing specifically on geopolitical risk events.

The ongoing conflicts in the Middle East affecting global energy markets and the trade tensions reshaping supply chains confirm that this supervisory focus is well-justified. The ECB's recognition of geopolitical risk as a distinct, cross-cutting risk driver reflects the reality that European banks face immediate, material threats to financial stability that demand urgent attention.

Yet precisely because geopolitical risk now commands such intense supervisory focus, it is critical to ensure that the analytical frameworks used to assess these risks are comprehensive enough to capture their full scope. The question is not whether to prioritize geopolitical risk, but rather whether current approaches fully capture the structural, longer-term geopolitical developments that are already creating spillover effects, including through climate risk transmission channels.

Geopolitical Risk: A Cross-Cutting Threat

The ECB defines geopolitical risk as "the threat, realisation and escalation of adverse events associated with wars, terrorism and any tensions among states and political actors that affect the peaceful course of international relations." Recent ECB and ESRB analysis has further refined this understanding, categorizing geopolitical risks into five distinct dimensions: military conflicts and wars; infrastructure vulnerabilities (including energy and digital systems); trade disruptions and sanctions; capital and financial market risks; and political or societal factors. Each category captures different facets that can amplify macro-financial vulnerabilities and threaten financial stability.

The transmission mechanisms through which these acute risks affect banks are well understood. Through the financial markets channel, heightened uncertainty and risk aversion can trigger asset price fluctuations, disrupt global capital flows and increase volatility, eroding the value of banks' portfolios and raising market and funding risks. The real economy channel operates through tariffs, sanctions and disrupted supply chains, creating inflationary pressures and weakening economic conditions that underpin credit portfolios, leading to higher default rates and increased provisioning requirements. Finally, the safety and security channel affects operational resilience directly through cyberattacks, service interruptions and damage to physical infrastructure or critical third-party providers can severely compromise banks' ability to function.

To manage the effects from these specific channels, the ECB has already begun putting banks to the test. Through initiatives like the 2024 cyber resilience exercise and the 2025 EU-wide stress test, regulators are actively working to better understand the real-world implications of geopolitical risks on bank balance sheets.

While this rigorous testing is both necessary and typical for the mechanics of a stress test, its heavy reliance on short-term shocks introduces a critical blind spot. Geopolitical risk is not only about sudden disruptions. By focusing so intensely on the short term, current frameworks risk missing the structural, longer-term geopolitical developments that unfold over years rather than days. These developments may not trigger immediate financial stress today, but they are already reshaping the landscape in ways that create substantial, unpriced risks for tomorrow, most notably by amplifying climate risks.

Structural Geopolitical Shifts and Climate Risk Transmission

When nations prioritize strategic independence over global integration, environmental targets often become collateral damage. To illustrate how these long-term geopolitical strategies quietly translate into climate-related financial risks, we can examine two prominent examples: the energy paradox around the race for technological dominance, and the weaponization of clean energy supply chains.

The AI Energy Paradox: The revival of fossil fuel dependency in the name of technological progress

Take for instance the global race for artificial intelligence supremacy. This is fundamentally a geopolitical competition as nations view AI capabilities as strategic assets essential to economic competitiveness, military advantage and technological independence. The contest between the United States, China and the European Union for AI dominance could, in extreme scenarios, even fuel future conflicts. Yet long before any such scenario materializes, the AI race is already creating profound climate consequences through specific, identifiable transmission channel: the energy sector.

Global electricity generation to supply datacentres is projected to surge from 460 terawatt-hours in 2024 to over 1,000 TWh by 2030 and 1,300 TWh by 2035, according to the International Energy Agency. To feed the massive energy needs of this transition and ensure domestic data sovereignty, less sustainable alternatives for energy generation have rapidly regained relevance.

In the United States, where natural gas supplies over 40% of datacentre electricity and coal approximately 15%, the AI boom is breathing new life into fossil fuel generation. Coal-fired generation increased 13%, or 64 terawatt-hours, through September 2025. Maryland's Brandon Shores coal plant, slated to close in 2025, will now remain operational until 2029 to serve as a "power bridge" for the AI boom. Michigan's J.H. Campbell coal facility received a similar extension beyond its planned May 2025 closure.

For European financial institutions, the true danger lies not just in directly financing these datacentres, but in the macroeconomic fallout of this fossil fuel lock-in. While the epicentre of the AI energy surge is currently in the United States and China, this geopolitical tech race is rapidly consuming the global carbon budget, creating severe spillover risks for European banks.

First, the resulting delay in global decarbonization accelerates physical climate risks worldwide. A reality acutely understood in highly exposed, sea-battling economies like the Netherlands, where accelerating sea-level rise poses systemic economic threats. Second, it triggers a severe "strong shoulders" transition risk: If the global tech sector refuses to decarbonize in its pursuit of AI supremacy, European regulators will be forced to demand aggressively steeper emission cuts from traditional European sectors, such as manufacturing, agriculture, and real estate, to compensate and meet overarching EU net-zero targets. Consequently, European banks whose loan books are heavily concentrated in these traditional sectors will face sudden, severe transition risks and portfolio devaluations, all sparked by a geopolitical arms race happening an ocean away.

Critical Mineral Chokepoints: Supply Chain Weaponization Delays the Energy Transition

A second example relates to the control of raw materials essential to clean energy technologies. As the world attempts to decarbonize, geoeconomic tensions are increasingly weaponizing the green supply chain. A clear example is China’s recent decision to impose severe export controls on rare earth elements.

To understand the climate impact, one must understand the technological chokepoint: these specific rare earth elements are irreplaceable inputs needed to manufacture sintered permanent magnets. These magnets are the driving force inside electric vehicle (EV) motors and offshore wind turbine generators. Because China controls an estimated 94% of global magnet manufacturing, their restrictions on the raw elements caused an immediate, severe supply shock, with global magnet exports plummeting to multi-year lows in mid-2025.

The climate transmission channel here is direct. By choking off the supply of these critical components, this strategy amid geopolitical tensions actively delays clean energy deployment and prolongs global fossil fuel dependence. Furthermore, as Western countries rush to build redundant, alternative supply chains to bypass these chokepoints, they lose the economic efficiency of globally optimized networks. This fragmentation effectively embeds a permanent "climate risk premium" into the cost of the green transition.

For European banks, this geopolitical bottleneck translates directly into credit and transition risk. Massive loan exposures to the European automotive industry confront the reality that electric vehicle production may soon be constrained not by consumer demand, but by a lack of magnets. Similarly, financed portfolios heavily weighted toward renewable energy projects face unpredictable cost overruns and deployment delays. Once again, the weaponization of supply chains is placing a costly risk premium on the exact technologies needed to achieve climate targets.

The Path Forward: Expanding Risk Frameworks for Broad-Based Resilience

These two examples demonstrate a fundamental truth: applying a long-term perspective to geopolitical risk is a financial necessity. (Reverse) stress tests are vital tools for ensuring capital adequacy against sudden, violent shocks. However, they are inherently the wrong mechanism for managing structural, decade-long shifts. Stress tests typically assume a static baseline disrupted by a temporary crisis. But the global race for technological supremacy and the reorganization of green supply chains represent a permanent rewiring of the global economy.

To navigate this interconnected risk landscape, the ECB's concept of "broad-based resilience" provides a useful organizing principle. As Claudia Buch emphasizes, resilience is not about predicting specific crises, but about maintaining strong capital and liquidity buffers, robust governance and operational flexibility to buffer a range of shocks, both immediate and structural, both geopolitical and climatic.

Strategic Imperatives for Financial Institutions

To achieve this broad-based resilience, banks must move beyond basic compliance and adopt four strategic imperatives:

1. Strengthen board-level governance: Board-level understanding of these interconnected dynamics is essential. Boards can no longer treat geopolitics and climate as isolated dashboard metrics. Risk appetite statements must address both immediate shock scenarios and longer-term structural shifts, formally recognizing how global tensions actively alter the bank's climate goals.

2. Master Scenario Thinking: The ECB's 2026 geopolitical risk reverse stress test presents an opportunity to expand beyond immediate shock scenarios. It is vital to ask explicit questions, such as: How do rare earth export restrictions sustained over five years affect transition plan viability? But the real value lies in the strategic discussion itself. Even if a compound shock cannot be perfectly quantified today, debating its directional impact on the bank's long-term business model is a competitive necessity.

3. Enforce concrete, forward-looking due diligence: Credit assessments must capture these compounding risks. Practically, this means requiring borrowers in vulnerable sectors to map upstream (Tier 1 and Tier 2) suppliers before approving green transition loans. For tech clients, underwriting models should utilize "carbon shadow pricing" to account for the risk of local power grids reverting to fossil fuels during geopolitical stress.

4. Recognize the limits of public bailouts: During the COVID 19 pandemic, fiscal support in the euro area reached approximately 4% of GDP. This public insurance protected financial institutions from significant losses. However, with elevated fiscal debt levels and, the availability of similar support in future crises cannot be assumed. The increased defence spending needs driven by the very geopolitical tensions discussed are a clear reference for budgetary impacts. Looking ahead, preserving current capital buffers against these structural risks (rather than assuming the state will absorb the shock) must become a guiding strategic principle.

Conclusion: Comprehensive Frameworks for Complex Risks

The ECB's elevation of geopolitical risk to the centre of its supervisory priorities reflects an accurate and necessary assessment of current threats to financial stability. The 2026 reverse stress test and ongoing supervisory scrutiny will reveal vulnerabilities and drive improvements in banks' management of immediate geopolitical shocks.
But if risk assessment frameworks focus exclusively on acute crises while overlooking structural geopolitical shifts, they will miss transmission channels that are already creating material risks. As we have seen, the geopolitical drive for AI supremacy and the weaponization of critical mineral are not just diplomatic issues, they are directly amplifying climate and transition risks on European balance sheets.

At RiskSphere, we work with financial institutions to navigate precisely these complexities. Our expertise in regulatory compliance, climate risk management and strategic risk assessment positions us to support the development of integrated scenarios, governance frameworks and portfolio resilience strategies that capture the full scope of interconnected risks. As the ECB intensifies its focus on geopolitical risk through the 2026 stress test, now is the moment to ensure your institution's risk management framework captures the critical transmission channels that will define financial stability in the decade ahead.

The geopolitical landscape is not separate from the climate challenge, it is actively reshaping how climate risks materialize and intensify. Financial institutions that recognize this reality and act on it will be better positioned not merely to manage compliance requirements, but to navigate the compound uncertainties ahead with clarity and resilience.