The European Central Bank’s (ECB) latest Financial Stability Review has warned the ongoing war in the Middle East poses a test to the resilience of the global financial system.

The euro area’s outlook for financial stability is being shaped by geoeconomic stress and energy supply disruptions, the review said, with the severity and duration of the fallout still uncertain.

“The current energy supply shock poses upside risks to inflation and downside risks to economic growth,” said ECB vice-president Luis de Guindos. “It could also increase market volatility and challenge debt servicing capacities as financing costs rise in an environment of weaker economic growth.”

Despite “remarkable” resilience coming into 2026, the war in the Middle East has led to a major geoeconomic shock that is testing the global financial system, the ECB said. Alongside this, lingering uncertainty over global trade and international cooperation has added to the stress.

An environment of stretched equity valuations combined with compressed corporate risk bond premia mean there is significant downside risk related to geopolitical, fiscal and macroeconomic developments. The ECB believes these risks are currently underestimated, creating a “fair risk” that financial market sentiment could deteriorate as the war goes on.

Non-banking institutions have so far been largely unaffected by the war, which began when the US initiated a bombing campaign against Iran that was widely considered illegal under international law.

However, a broad-based market downturn could pose threats to the private credit market given its low liquidity buffers, high portfolio valuations and exposures concentrated in a small number of sectors. The ECB released a document on Tuesday stating that private credit does not pose a systemic risk to the eurozone, but it noted in its review that it warrants close monitoring due to spillover risks.

In response to these threats, the ECB recommends regulators maintain current capital buffer requirements and borrower-based measures, while EU nations require a “comprehensive” policy response to address persistent liquidity and leverage vulnerabilities in the private lending sector.

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