Central Banks Cite Geopolitical Conflicts as a Top Risk

Geopolitical turmoil has been around ever since nation-states were first formed millennia ago. Some of the earliest global conflicts were the Trojan War between the Greeks and the city of Troy and battles between non-Roman Germanic tribes sometimes referred to as Barbarians and the Roman Empire. In the 20th century, World Wars I and II were devastating global conflicts that reshaped the world.When it comes to the biggest risks faced by community financial institutions (CFIs), you might not think that geopolitical turmoil would be high on the list. However, CFIs may be more susceptible to these risks than it appears at first glance.In a survey of central banks and sovereign wealth funds conducted by the World Economic Forum (WEF), geopolitical tensions were cited by 83% of respondents as the biggest risk to global economic growth. This was followed by inflation and tighter monetary policies (73%), fallout from the Russia-Ukraine conflict (50%), and supply chain disruptions/commodity price spikes (50%).How Geopolitical Risk Applies to CFIsThere are several ways that CFIs with a local footprint could be more vulnerable to geopolitical risks than one might expect. For example, small business customers have exposure to the global supply chain, especially via imports and exports. There could also be a foreign-owned manufacturing plant located in the CFI’s US market area.Broader regional conflicts and strained relationships between large economies are particular geopolitical dynamics CFIs should watch closely. The WEF survey noted that persistent global tensions among major powers are a key driver of banks’ heightened focus on geopolitical risks. Meanwhile, the wide-ranging tariffs introduced this year by the federal government could threaten worldwide economic growth and contribute to continued worries of a recession here in the US.  Preparing for Heightened Geopolitical RiskCommentary from risk professionals notes that, while no bank can eliminate geopolitical risk, institutions of all sizes can take practical steps to better understand their exposure and embed this into existing risk frameworks. In the current environment, it can be helpful for all financial institutions to periodically review the geopolitical landscape and consider scenarios of how they will impact their institutions and strategies for addressing these potential disruptions and risks. Central banks and sovereign wealth funds are taking steps to prepare for heightened geopolitical risk. For example, 53% of the WEF survey respondents plan to increase the size of their reserves over the next two years, while 52% plan to diversify their holdings. While CFIs operate on a very different scale, similar principles around building buffers and diversifying sources of resilience can inform how institutions think about preparing for shocks.Proactive Planning Is KeyIt may be helpful for CFIs to take a proactive look at the potential impact of unforeseen geopolitical events on their balance sheets and profits. Many institutions start by reviewing or strengthening frameworks for managing geopolitical-related risks, including increased fraud and anti-money laundering (AML) vulnerabilities, within their existing risk-management programs. Some risk experts suggest that CFIs review how sanctions compliance, fraud controls, and AML programs would perform under different geopolitical scenarios, and document clear communication channels with regulators and key stakeholders.Scenario planning is another potentially useful strategy, where CFIs conduct stress tests to determine how macro events could affect their lending portfolios. These exercises can help you prepare and discuss among the management team and board about complex geopolitical developments that go beyond credit risk.Geopolitical tensions and risks aren’t expected to subside anytime soon. Over half of the WEF survey respondents predict a degree of geopolitical instability and moderate risk of global catastrophes over the next two years, while 30% anticipate even more global turmoil. Long term, two-thirds predict either stormy or turbulent geopolitical conditions over the next decade.Plan to meet with your executive team and board of directors to discuss ways your CFI can assess your exposure to rising geopolitical risks and manage this risk accordingly, in the context of your institution’s broader risk framework.