Against a backdrop of geopolitical fragmentation, sanctions escalation, regional conflicts and hybrid threats, reverse stress testing is forcing organisations to recognise what has long been true: geopolitical risk is not peripheral, but a core driver of financial and operational resilience.
As these shocks increasingly transmit through second- and third-order channels – from sanctions to supply chains to balance sheets – financial institutions face a new regulatory requirement: stress-testing to help understand how a business model could fail. The European Central Bank (ECB) is to require the banks it supervises under the Single Supervisory Mechanism to conduct a geopolitically driven reverse stress test as part of a 2026 thematic exercise.
‘Even where impacts are common, the magnitude and materiality are very different firm by firm’
Sharpened focus
But reverse stress testing isn’t just for the banks. It flips the traditional approach of all entities: rather than modelling predefined adverse scenarios, organisations work backwards from a defined failure point – for example, a severe capital depletion – to identify the scenarios and transmission channels that could plausibly cause it.
The ECB has deliberately not prescribed scenarios, which forces banks to identify their own vulnerabilities rather than relying on regulator-designed narratives. This has sharpened focus on hybrid threats, such as the interaction between geopolitical escalation, cyber disruption, sanctions, funding markets and operational resilience.
Speaking at a recent risk community session run by ACCA, Derek Leatherdale, senior geopolitical risk adviser at Sibylline and former head of HSBC’s geopolitical risk function, pointed out: ‘Geopolitical risks are idiosyncratic. Even where impacts are common, the magnitude and materiality are very different firm by firm.’
Practical challenges
A number of practical challenges arise in the implementation of reverse stress testing. Also speaking at the session, which included CROs, Steve Bailey, immediate past chair of ACCA’s global forum for governance, risk and performance, said the benefits are clear – it engages clients at an early stage as they can start with what they perceive to be realistic risk outcomes – but the downsides are significant.
‘Values are subjective, aggregation is really complex and the scope is daunting,’ Bailey said. ‘External risks, geopolitical risks and operating risks should all be included, and that’s a huge vision and knowledge field.’
Reverse stress testing is increasingly necessary but remains a significant undertaking
Bailey pointed out that the identified risks also tend to be based on known or historical risks rather than emerging risks or black swans, ‘so you could be fooling yourself with the outcome’. The real crunch comes, he added, when it comes to accounting for and reporting these current or potential risks: ‘The profession is not addressing this issue as well as we should be.’
These observations capture the tension many practitioners face: reverse stress testing is increasingly necessary but carrying it out well remains a significant undertaking.
Uncomfortable but valuable
Reverse stress testing may be seen as uncomfortable but it is valuable precisely because it forces companies to confront how their business model could fail, not just how it performs under adverse conditions. It often exposes concentration risks linked to geography, funding or counterparties, said Leatherdale, as well as ‘assumptions about market liquidity under stress and over-reliance on management actions that may not be feasible in a crisis’.
Embedding geopolitical risk into enterprise risk management is no longer optional
He cautioned that unstructured or informal analysis risks being ignored: ‘If you’re a risk function talking about geopolitical risk, you need to produce analysis that people can actually operate to,’ he said. ‘Otherwise, you lose out to informal or armchair analysis.’
However, the discussions revealed broad consensus on emerging good practice for embedding geopolitical risk in reverse stress tests:
- board and executive sponsorship, typically via the board risk committee
- integration into stress testing, the International Capital Adequacy Assessment Process and strategic planning
- cross-functional engagement across risk, finance, legal, compliance, cyber, HR and government affairs
- bespoke scenario design, grounded in firm-specific exposures.
Vital considerations
The real value from assessing geopolitical risk comes when the results are embedded into decision-making. Having geopolitical risk on a register is insufficient; firms need analytical frameworks that translate external developments into actionable business intelligence.
Clear ownership, cross-functional collaboration and board-level sponsorship are essential to move beyond theoretical exercises. Leatherdale emphasised that effective geopolitical risk management is fundamentally about preparedness and decision-making, not prediction – echoing US President Dwight D Eisenhower’s observation that ‘Plans are useless, but planning is essential’.
The value lies in the process of thinking through scenarios, identifying vulnerabilities and establishing response frameworks, rather than in accurately forecasting which specific scenario will unfold.
However, while financial and other institutions are increasingly building dedicated geopolitical risk capabilities, appointing heads of geopolitical risk, they often lack geopolitical specialists.
Strong CRO leadership is pivotal in making this work. As Leatherdale pointed out: ‘The best CROs aren’t the ones who try to know everything; they’re the ones who make sure everyone else knows what they know.’
Looking ahead
As supervisory expectations sharpen and geopolitical volatility persists, embedding geopolitical risk into enterprise risk management is no longer optional. Tools such as reverse stress testing, coupled with robust governance and cross-functional engagement, are becoming essential to understanding how geopolitical shocks could crystallise into financial distress.
The message for risk leaders is that geopolitical risk is systemic and cuts across functions, requiring shared accountability, behavioural awareness and board-level ownership.
More information
Read more outputs from ACCA’s risk community session. ACCA’s risk community covers all sectors and regions. For enquiries contact its chair Rachael Johnson.
