Financial services: Navigating the new trade war

Political background

Since early 2025, under President Donald Trump’s second term, the United States has escalated tariff actions on a wide array of imports, reigniting global trade tensions. A series of key announcements* has introduced significant volatility into financial markets:

• February 2025: 15% tariffs reinstated on Chinese consumer electronics and machinery.
• March 2025: 25% duties applied to EU steel and aluminum exports.
• 2 April 2025: “Liberation Day” – the US declared a universal 10% tariff on all imports effective April 5, alongside additional tariffs targeting over 60 countries:
  • China: 104% total tariff load after further escalation on 8 April.
  • EU: 20% reciprocal tariff.
  • Canada and Mexico: 25%.
  • Japan, South Korea, India: 24–26% range.
• 9 April 2025: In response, China implemented sweeping 84% retaliatory tariffs on US goods. That same day, the global financial markets experienced a dramatic sell-off in US Treasuries. Concurrently the US administration announced a 90-day pause on additional tariffs beyond the 10% baseline, with one exception: tariffs on Chinese goods were raised further to 125%, effectively severing bilateral trade.

*This context is accurate as of 10 April 2025. However, given the extreme pace of political decisions and market reactions, both credit risk assessments and scenario calibration should be revisited frequently.

Macroeconomic instability and scenario outlook

The combination of rising tariffs, supply chain disruption, and geopolitical tension has introduced great uncertainty to the macroeconomic environment. Various institutions now forecast:

• Slower GDP growth: several advanced economies, including Germany and France are seeing their GDP projections revised downwards.
• Persistent inflation: underlying inflation is now projected to remain above central bank targets in many countries in 2026.
• Rising unemployment: with job losses particularly concentrated in export-driven sectors such as manufacturing and logistics.
• Increased global default rates: Moody’s projects a possible increase in global default rate to 8% over the next year from less than 5% today if high-yield bond spread continue to widen.

Together, these dynamics have reintroduced the risk of stagflation. Central banks must now balance between limiting inflation and supporting deteriorating economic activity.

To assess these impacts, we have developed and applied impact analyses on corporate portfolios based on the following scenarios:

1. March 2025 tariffs: Sector-specific disruption (e.g. metals, electronics).
2. April 2025 tariffs: Broad tariff application + worsening global outlook.
3. Further escalation: Hypothetical increase of current tariffs on major partners.

Impacts on financial institutions

Tariffs affect financial institutions both directly and indirectly, stressing Expected Credit Loss (ECL) calculations and increasing provisioning requirements. This is particularly relevant under IFRS 9, which relies on a forward-looking impairment model.  While this methodology provides a more dynamic view of credit risk, its application becomes more complex during periods of heightened volatility and policy uncertainty.

Furthermore, IFRS 9 introduces a three-stage model for impairment, where exposures move from Stage 1 to Stage 2 upon signs of a Significant Increase in Credit Risk (SICR). To assess SICR, institutions must consider not only borrower-specific indicators but also broader macroeconomic conditions. Staging migrations have material implications: Stage 2 exposures are subject to lifetime ECLs, as opposed to the 12-month ECLs prescribed for Stage 1 exposures.

Tariff impacts on credit risk

In our analysis, we have classified tariff impacts into two categories:

• Direct impacts, where tariffs increase the risk of default for borrowers operating in affected sectors or geographies, leading to immediate staging impacts.
• Indirect impacts, where tariffs disrupt macroeconomic fundamentals such as GDP growth, inflation, and unemployment. These in turn affect model parameters such as Probability of Default (PD) and Loss Given Default (LGD), driving higher ECL through forward-looking scenario weightings and sensitivities.

Direct impact – staging shock

Institutions with high exposure to vulnerable sectors may face rapid Stage 1 to Stage 2 transitions under the SICR framework. The increase in ECL is non-linear due to lifetime provisioning. To assess this risk, we conducted 100,000 simulations, applying random staging shocks across representative corporate banking portfolios.

Our simulations show that even moderate staging shocks can lead to material increases in credit provisions. When just 10% of Stage 1 exposures are moved to Stage 2, total ECL rises by approximately 18%. At the 30% shock level, the increase reaches nearly 56%, with the Stage 2 provisions more than tripling compared to the original baseline. This disproportionate impact highlights the non-linear nature of staging effects: Stage 2 exposures require lifetime ECL, whereas Stage 1 exposures are limited to 12-month losses.

These results are particularly relevant today. Moody’s recently warned that global default rates could surge from under 5% to 8% – a 60% relative increase – if current credit market conditions continue.

For financial institutions, this reinforces the importance of early-stage risk detection, frequent stress testing, and proactive staging governance. Even before actual defaults materialise, the forward-looking nature of IFRS 9 can drive material provisioning changes, especially when geopolitical risks escalate suddenly.

Indirect impact – macroeconomic variable stress

Macroeconomic variables affect the forward-looking component of ECL models. We stressed exposures using scenario-driven shocks based on various market studies of tariff impacts on the economy. These macroeconomic shocks affected both model parameters (PD and LGD) and staging transitions.

We applied three distinct macroeconomic scenarios reflecting the progressive escalation of trade tensions:

1. Scenario 1: March 2025 tariffs – Sector-specific disruption, particularly in high-tariff industries such as metals, machinery, and electronics.
2. Scenario 2: April 2025 tariffs – A broader tariff shock across all imports, leading to general deterioration in economic outlook, employment, and inflation expectations.
3. Scenario 3: Further escalation – A hypothetical scenario assuming a further increase of tariffs on all major partners, significantly weakening GDP and increasing financial market stress.

Each scenario was translated into macroeconomic variable assumptions, which were then propagated through ECL models. The analysis measured the impact relative to the baseline, i.e., comparing the stressed results to the initial (unweighted) baseline scenario.

The results reveal a compounding effect of the increase in Stage 2 ECL and a worsening of model parameters, amplifying ECL without explicitly changing borrower-level creditworthiness.

These results underscore the importance of assessing both direct and indirect impacts within credit risk frameworks. While direct sectoral shocks may appear more immediate, changes in macroeconomic variables can have far-reaching and compounding effects across portfolios. A robust approach to scenario design and stress testing should consider a broad range of transmission channels to ensure resilience under evolving economic conditions.

Conclusions

“There are known knowns. These are things we know that we know. There are known unknowns. That is to say, there are things that we know we do not know. But there are also unknown unknowns. There are things we do not know we do not know.”

Donald Rumsfeld

As we navigate through a new era of economic instability, financial institutions must prepare for conditions that few would have anticipated even months ago. The rapid escalation of tariffs, the breakdown of major trading relationships, and the emergence of stagflationary forces are reshaping credit and market risk dynamics across sectors and geographies.

In this context, risk models and scenario frameworks must evolve quickly and proactively. Institutions must broaden their field of vision, stress not only the obvious vulnerabilities but also the second- and third-order effects coming from the interlinks of global dependencies.

Forward-looking credit modeling was designed to anticipate stress before it materialises. This can only succeed when inputs and scenarios are revisited in real time. Institutions should consider scenarios in creative ways to capture unconventional risks (trying to address potential unknown unknowns).

The current environment requires proactivity, agility, and close alignment between credit risk teams, economists, and senior management. Institutions that wait for clarity may find themselves reacting too late.