The respite was brief. Global financial institutions (FIs) now face a whole new set of potential macro-financial shocks, triggered by escalating trade tensions. S&P Global Ratings believes the ripple effects will be felt widely though unevenly.

Global FIs enter these more difficult credit conditions from a position of strength, with generally solid credit fundamentals. Our base case is for ratings stability in 2025. Still, the banks and other FIs face many unknowns. In this uncertain environment, we seek to add some transparency on how we are thinking about and looking at the transmission channels to FIs from evolving trade stances and policy uncertainties (see "Global Credit Conditions Special Update," published on RatingsDirect on April 11, 2025).

The most imminent risk to global FI credit is market volatility. The drag on economic growth will more gradually transmit to banks through lower business volumes and higher credit losses. Finally, the ongoing global trade reshuffling could lead over time to a redesign of the architecture of the global financial system.

Three Transmission Channels: Volatility, Economic Pain, Financial Architecture

The macro-financial effects from intensifying trade tensions and policy uncertainties may increase risks for global FI through three key channels (see illustration 1).

Illustration 1

Market volatility has raised counterparty risk.  Financial markets reacted swiftly to the U.S. announcements on tariffs, with volatility hitting a multi-year high. Global banks with trading operations tend to garner higher revenues from some degree of market volatility. But a sustained period of volatility--particularly in bond and foreign exchange markets--could expose known or unknown vulnerabilities in the global financial system.

For example, higher margin calls could stress the liquidity of nonbank actors. This might spur fire sales of underlying assets, setting in play a downward spiral as seen in past financial crises. What's more, hedge funds-–the most levered nonbank actors--now play a meaningful role in the U.S. Treasury market.

So a broad deleveraging could hit market funding conditions and hurt borrowers with short-term or large external refinancing needs, including nonbank financial companies, securities firms, and some emerging market banks. While the market appears to have ridden through the initial wave of volatility and margin calls, this remains an important latent risk.

A second key channel is the trade impact on the broader economic environment.  The prevailing uncertainty is likely to undermine business and consumer confidence, which can weaken corporate investment, employment and consumer spending, and overall economic activity.

For global FIs, this will likely dampen credit demand and the flow of investment banking revenues linked to mergers and acquisitions (M&A) and origination. What's more, many global banks may need to boost credit-loss provisions in response to weaker economic expectations. All this points to a drag on profits for global banks, a trend that we already expected for this year.

That said, as at this time of writing, our economists do not forecast a recession in major global jurisdictions. In line with this view, we expect any asset-quality deterioration to remain contained and limited to the most vulnerable portfolio, such as small and midsized enterprises (SMEs). Also sensitive are corporates that derive a significant portion of their revenues from exports or are exposed to global supply chains, e.g., automakers, retailers, and generic drug manufacturers. Banks with outsized exposure to directly targeted countries will also be more vulnerable.

Finally, the ongoing global trade reshuffling could also lead over time to a broader redesign of the global financial system architecture.  The globalization of the financial markets was underpinned by a high degree of global coordination on financial regulation, with the Basel accords a key mechanism to achieve global alignment, and on financial stability management, with the Federal Reserve's U.S. dollar swap lines playing a central role in times of crisis. We continue to see a fundamental challenge to these key pillars of global financial stability as a remote possibility.

That said, the fact that doubts are emerging about the commitment of key policymakers to this global architecture could lead to higher costs and risks for the most globally active banks.

In our view, potential macro-shocks would not land evenly (see illustration 2).

Illustration 2

Global Banks Are Well-Placed To Navigate Volatility, But Not Immune To Financial System Vulnerabilities

Global FIs must first navigate the near-term market volatility resulting from the intensification of trade tensions and policy uncertainties. Some market volatility can create revenue opportunities for banks with significant trading operations and securities firms (see "Capital Markets Could Support Bank Revenue In 2025, But Uncertainty Due To Tariffs Is High," April 9, 2025 ). These include larger trading flows--e.g., to meet clients' needs to reposition their portfolios for the new economic reality or for hedging purposes--and higher bid-ask spreads. Past stress episodes have confirmed that banks with large trading operations are usually initial beneficiaries of financial market volatility.

For major banks, the situation is multilayered. Episodic bursts of high market volatility heighten their counterparty credit risk, especially for the ones exposed to liquidity-poor buyside clients and nonbank financial institutions (see "Systemic Risk: Global Bank-Nonbank Nexus Could Amplify And Propagate Market Shocks," Feb. 18, 2025). A handful of global investment banks and securities firms face meaningful counterparty credit risk related to their prime brokerage services.

We believe enhancements to risk management has supported the markets' ability to cope with the substantial margin calls, particularly in equity and equity derivatives. Global policymakers and regulators responded to a series of market events between 2020 and 2023, including COVID-19 lockdowns, the energy crisis, the U.K. gilt sell-off and the failure of Archegos Capital Management. They have pushed the financial industry to reduce procyclicality and improve transparency of clearinghouses' margin models, and work with end-clients to improve their liquidity resilience.

U.S. dollar and Treasury disruption could become a different kind of test

In recent years, hedge funds have taken an increasingly important role in the U.S. Treasury market. This notable market trend largely results from leverage-heavy basis trades. Given its obvious crucial importance for the global financial system, an adverse movement in the U.S. Treasury market, for instance due to deleveraging by hedge funds, would reverberate. For example, funding conditions would likely deteriorate for many economic actors, such as certain banks and nonbank financial institutions.

In our view, nonbank finance companies, securities firms and some emerging market banks with a strong reliance on external U.S.-dollar funding would be most exposed to such a tightening in market funding conditions. Globally active banks, on the other hand, typically have strong and diversified funding franchises, including deposits. This would limit the broader funding risks from dollar volatility.

Should the market volatility escalate into a broader turmoil affecting key funding markets, such as the U.S. Treasury market, we believe that major central banks would make use of various tools to mitigate the market impact. This could include appropriate adjustments to policy rates. Both the European Central Bank and the U.S. Federal Reserve have stated in the past few days that they are ready to use the tools that they have available to support financial stability. For instance, their refinancing facilities are open to banks with funding challenges, subject to the provision of adequate collateral, and in a worst-case scenario they could make direct purchases to backstop key funding markets, as the Bank of England did in September 2022.

That said, such actions would add complexity for central banks needing to address the risks to inflation and growth created by trade tariffs.

A Slower Burn: Trade Tensions And Policy Uncertainties Will Weigh On Business Prospects And Possibly Asset Quality

We expect the slowing of global economic activity to gradually weigh on financial institutions, particularly in countries that could be targeted by the most severe tariffs and with outsized implications on smaller and trade dependent economies. The earliest potential effects will be on FIs that have larger exposure to the directly targeted sectors and countries.

Faced with these uncertainties, corporates and households may delay or downscale investments or consumption. This will weigh on global banks' business activity and profits along three main drivers:

• First, the current volatile environment will likely slow M&A transactions and overall capital market origination, a trend which has been at play since the start of this year.
• Second, many global banks expected that, in 2025, lower policy rates and improved economic conditions would lead to higher credit demand and therefore higher lending volume. This recovery in loan volumes is likely to be dampened by weaker economic growth, although higher for longer long-term rates would be a positive for margins.
• Third, most global banks have moved to provisioning models based on expected rather than incurred loss. This means that, as they downgrade economic forecasts, banks typically proactively raise their credit loss provisions. We expect this to be most meaningful for U.S. banks, where model provisions are typically swiftly made and significant, and the emerging markets most exposed to tariffs.

The magnitude of impact on global banks' asset quality will depend on the duration of the current trade tensions, and whether they escalate.

A Redesign Of The Global Financial Architecture Would Present Some Tough Questions For Globally Active Banks

The intensification of global trade tensions could be the start of a broader economic reshuffling. That, in turn, has implications for the global financial system architecture.

In the past few decades, the globalization of the financial system was enabled by a degree of technocratic coordination on two key matters: financial regulation and financial crisis management. Both were embodied by specific institutions (e.g. the Basel Committee on Banking Supervision, the Financial Stability Board) or institutional arrangements (e.g. central bank reciprocal swap lines). For global banks, doubts on the lasting commitment to this global financial architecture could over time raise risks and costs.

On the global regulatory front, we believe that some simplification of existing rules, as well as a sense of regulatory saturation, is inevitable.  This is most apparent in the difficulties in finalizing the implementation of Basel III in key global jurisdictions. A broader regulatory rollback is not our base case today, but if such a path were followed, it could have negative implications for bank ratings (see "Systemic Risk: Global Banking Regulation At A Crossroads," Feb. 18, 2025).

Subordinating prudential objectives to broader political goals (such as economic competitiveness) could sow the seeds of financial instability. Further, global regulatory fragmentation would represent a meaningful risk and cost for globally active banks subject to multiple authorities and rulebooks. A prime example are rules and expectations for the management of climate-related risks, which are at very different degrees of development across major jurisdictions.

Some banks may begin to question whether the commitment to global backstops will weaken; this could lead them to alter their business exposures over time.  The safety of the financial system requires a degree of coordination between authorities in times of crises. This is both on the micro-side (i.e., to manage specific crisis cases, the most recent example being the failure of Credit Suisse) and on the macro-side (i.e., to coordinate central bank announcements and measures, the most recent example being the response to the COVID crisis in March 2020).

Given the prominence of the U.S. dollar in the global financial system, this minimum level of coordination is hardly conceivable without a commitment from U.S. authorities to contribute to global financial stability, for instance by providing a backstop to global needs for U.S. dollar-denominated liquidity in the form of central bank swap lines, in case of stress (see sidebar below).

Our base case remains that such cooperation between authorities would be forthcoming in times of crisis, given the shared interest in ensuring global financial stability. That said, for some globally active banks or banks with a positive net asset position in U.S. dollar, a doubt on the availability of such a public backstop could lead them to trim related business activities.

The Banks: A Synopsis Of Our Takes By Region

North American banks

Roughly 90% of U.S. banks we rate have stable outlooks. These banks have substantively strengthened their balance sheets over the past years and earnings will be only modestly lower in 2025, assuming a recession is avoided.

However, risks are to the downside. Banks would need to increase provisions for credit losses if the probability of an economic downturn rises. U.S. banks have exposures to a variety of companies exposed to tariffs. Higher prices and a rise in unemployment would hurt consumer asset quality. Market volatility also increase counterparty risks for the large banks active in trading.

We recently lowered our earnings forecast for Canadian banks as tariffs could more significantly hurt the Canadian economy. That said, the high degree of uncertainty implies a variety of outcomes, including the possibility of market support by the Canadian government.

Latin American banks

Latin American banks are entering this period of market volatility in relatively good shape, characterized by high levels of regulatory capital, sound profitability, and limited reliance on external funding. However, some countries are experiencing stressed asset quality metrics. This is mitigated for now by high provisioning coverage. A prolonged period of uncertainty would dilute those buffers.

The uncertainty surrounding tariffs is likely to suppress investments in the region, leading to weaker credit conditions and diminished market sentiment. As a result, asset quality may deteriorate, particularly in sectors heavily reliant on international trade, resulting in higher provisioning needs and reduced profitability.

Additionally, market volatility may negatively impact banks' investment portfolios, also pressuring profitability. Weaker economic conditions could also increase borrowing costs and restrict access to financing for affected sectors and lower-rated issuers, ultimately influencing banks' growth strategies and overall market stability.

Even though the U.S. government has delayed the implementation of tariffs on Mexico, we perceive a decline in investment and consumer sentiment in this country. Mexican banks will likely maintain prudent growth strategies based on conservative underwriting practices, given the tariff-related uncertainties. Consequently, we expect credit expansion to moderate this year, while asset quality metrics could deteriorate, though at manageable levels. We expect Mexican banks to maintain strong capital metrics and sound margins, offsetting pressures on asset quality and profitability.

China

Heightened market volatility, as well as counterparty failures and funding challenges, are imminent risks. But the pressure for the Chinese banking sector is relatively manageable considering banks' conservative appetite for market securities and very low external debt.

The drag on China's economy from higher tariffs will transmit to banks should high tariffs persist or prove long-lasting. Strains will incrementally come from Chinese sectors including micro and small enterprises and unsecured consumer credit.

Under our downside scenario for Chinese banks in which tariffs hit harder and the property sector doesn't hit its bottom, we project the nonperforming asset ratio could almost return to COVID-19 lockdown levels of 6.5% in 2022 (see "China's Bad Loans Could Exceed 6% In A Tariff-Related Downside," April 3, 2025). The downside scenario assumes GDP growth averages 3% over 2025-2027, compared with our existing base case of about 4%. In this lower growth scenario, we see credit losses rising to 1.2% of average loans in 2027, compared with 1.0% in 2024. This would put pressure on banks with marginal profit power or limited capital buffers.

We note however that Chinese regulators have adopted a wide range of prudential measures over the past ten years, which will improve the system's resilience, to an extent. What's more, the Chinese government has a history of strongly supporting the domestic capital markets. In an extreme scenario, we expect the government to step in to curb a systemwide risk spillover.

Most of our rated financial institutions are currently on stable outlooks, benefiting from government supports and a stable sovereign outlook. In the hypothetical situation that the outlook on the China sovereign is revised to negative, this would have a concomitant impact on the outlooks of many rated banks.

We are also wary of a deterioration of the stand-alone credit profiles of some nonbank financial institutions, noting many are buffered by strong, highly committed parent entities.

Japan

Given Japan is a domestic demand-led economy where export values are less than 20% of GDP, the banks should be able to manage the direct hit from escalating trade tensions and elevated uncertainty in the global economy. A slowdown of both domestic and global economies remains the biggest negative factor for the banking industry.

Upwardly moving domestic interest rates are a tailwind for banks, demonstrated by widening net interest margins, growth in loan demand, and low credit costs, among others. This tailwind should provide a cushion as global conditions test Japan's economy and the banks.

Major banks with international footprints, with overseas banking operations primarily in U.S. and Asia, are more vulnerable to global developments. However, major banks have stacked up their capital and earning buffers in recent years under record-high profits; they have already met their mid-term capital adequacy targets measured under finalized Basel III standards implemented in 2024. Implementation of Basel III to domestic-oriented banks are underway in 2025 as scheduled.

Japanese banks will continue to enjoy a good domestic funding environment but would be vulnerable to disruptions in dollar and other foreign-currency markets. This is due to their large loans and security investments in foreign currencies that are in part reliant on market-funding. The Bank of Japan has guided banks to focus on managing these risks and not to expect backstops. The BOJ limited the use of reciprocal swap lines in past times of systemic stress such as during the pandemic. Short-term or bank-specific difficulties in foreign-currency funding could damage the creditworthiness of affected banks.

The rest of Asia-Pacific

While recently proposed significant tariff increases by the U.S. are on a 90 day 'pause' they could eventually hit some Asia-Pacific economies and banks hard, if resurrected. Banking systems in economies where a high reciprocal tariff was initially proposed and that are big exporters to the U.S.--such as Cambodia and Vietnam--are at first view most exposed.

We note, however, that the Vietnamese and Cambodian banking sectors are already considered high risk, by global standards; the stand-alone credit profiles of banks are already firmly in speculative grade. A further dimension is the spillover on Asia-Pacific banks because of high China tariffs, given the interconnectedness of China and Asian neighbors.

We forecast a 12% increase in credit losses in 2025 to about US$81 billion for Asia-Pacific banks ex-China. Credit losses could increase beyond this in an environment of prolonged higher tariffs. That said, banks would be entering this environment in reasonably good shape and with some buffers at current rating levels. About 91% of bank ratings are on stable outlook and our economic risk trends for Banking Industry Country Risk Assessments (BICRAs) are stable in all the 19 banking jurisdictions we assess in the region.

With 15 of 19 governments in Asia-Pacific assessed by us to be supportive of systemically-important banks, banks are more closely correlated to changes in sovereign ratings or outlooks compared with other regions. Furthermore, we anticipate certain nonbank financial institutions, including some finance companies, leasing companies and real estate project financing companies, will be more vulnerable than banks if tariffs intensify.

European banks

The majority of rated European banks (circa 84%) have stable outlooks, and a further 11% have positive outlooks. European banks should continue to benefit from solid profitability, sound capitalization and liquidity, and relatively benign asset quality in 2025, in our view. Drivers include a favorable interest rate environment, but also from most banks' steady focus on derisking their balance sheets and controlling their costs in past years.

We also do not see major counterparty credit risk for the system as a whole because few banks have material prime brokerage activities. And some trading operations will benefit from more activity amid market volatility.

That said, the escalation of geopolitical and trade tensions present downside risks. Some European banks in France or the Netherlands rely on U.S. dollar/euro swaps to fund their net U.S.-dollar exposures. A change in the U.S. approach to central bank reciprocal swap lines could limit the extent to which these banks are able to run such operations. But we see this more as a long-term potential challenge than an imminent threat.

As such, the most relevant transmission channel from rising trade tensions on European banks would be via economic weakness. This in turn will depend on the tariff rate assigned to European exports to the U.S., once the 90-day pause comes to an end. While our economists revised down their economic forecasts in March, they do not forecast a recession for major European economies at this stage. For now, we expect the economic slowdown will mainly weigh on lending growth prospects, a negative for banks' profitability.

As for asset quality deterioration, it should remain limited to sectors most affected by U.S. tariffs such as chemicals, pharmaceuticals, metals and auto (see chart 1).

Chart 1

Emerging EMEA banks

We see three main channels of transmission for banks in emerging markets in Europe, the Middle East and Africa (EMEA):

• Oil price decline
• Capital outflows due to shifting investor sentiment
• Volatility in capital markets

We now expect oil prices to average a lower US$65 per barrel for the rest of 2025.  Prices should then increase to US$70 for the following years. Downside risks are on the rise. In our view, a significant reduction in prices could affect government spending and economic sentiment, and ultimately result in lower economic growth in oil exporting countries.

For many banking systems, this means higher pressure on asset quality. While we expect banks in the Gulf countries to remain resilient, Nigerian banks could be more vulnerable from an asset quality perspective. For oil importers, the impact would be positive.

Capital outflow risk could be exacerbated by political and geopolitical instability.  Ultimately, this could result in capital outflows from some emerging markets or difficulty to roll over existing external debt. Turkish and Qatari banks have the highest net external debt among emerging markets banks in EMEA. For Qatar, the risks are mitigated by the strong track record of extraordinary government support.

On the opposite end, Egypt's elevated external and domestic financing requirements make it susceptible to current global financial market headwinds. Egyptian banks might have to step in and replace international investors in case of significant divestment from government debt, increasing their already very high exposure to the public sector (62% of total assets as of end-2024).

Finally, the risk for banks could be exacerbated by the potential pressure on local currencies.

Banks' mix of investment portfolio vary by country.  Some, such as Egypt, are dominated by government bonds; others by highly rated securities like the Gulf Cooperation Council (GCC) banks. The increase in volatility in capital markets is unlikely to affect banks unless they must liquidate some of their investments to face capital outflows. Therefore, we expect the impact to remain manageable. Margin lending is also relatively limited in emerging markets and tend to be done with relatively conservative risk parameters.

Editor: Cathy Holcombe

Digital design: Halie Mustow, Jack Karonika

Related Research

• Credit Conditions Asia-Pacific Special Update: U.S.-China Ties In Uncharted Territory, April 15, 2025
• GCC Banks Can Cope With The Fallout From Intensifying Trade Tensions, April 15, 2025
• Global Credit Conditions Special Update, April 11, 2025
• Capital Markets Could Support Bank Revenue In 2025, But Uncertainty Due To Tariffs Is High, April 9, 2025
• China's Bad Loans Could Exceed 6% In A Tariff-Related Downside,April 3, 2025
• Systemic Risk: Global Banking Regulation At A Crossroads, Feb. 18, 2025
• Systemic Risk: Global Bank-Nonbank Nexus Could Amplify And Propagate Market Shocks, Feb. 18, 2025
• Asia-Pacific Financial Institutions 1Q 2025 Monitor: Most Banks Will Absorb U.S. Policy Volatility, Feb. 16, 2025