ECB, geopolitical risk and financial instability: indications for political and financial institutions

ECB slight drop in the cost of money for new

(Finance) – “Recent history suggests that it is unlikely that shock geopolitical alone cause a systemic crisis, but the latest developments require greater vigilance”. This is what an analysis of the European Central Bank on geopolitical risk and its impact on the financial stability of the euro area. The study highlights that major geopolitical risk events in recent decades – for example the 9/11 attacks – did not immediately trigger financial crises but in the current context geopolitical shocks can act as a trigger for unease systemic if they interact with pre-existing vulnerabilities. “In particular – the ECB economists highlighted –, the ifinancial stability could occur if a combination of several factors materializes, such as a very large shock, other sources of amplification and strong contagion.”

The study confirms that the risk geopolitical may have negative implications for the resilience of institutions financial. In particular, geopolitical risk could lead to, among other things, significant outflows and declining returns from investment funds. Likewise, geopolitical risk could lead to falling commodity prices actions bankingto the expansion of spread of CDS and to higher financing costs and provisioning needs for banks, which in turn would weigh on their profitability.

The tip to authority policies is to monitor geopolitical risk and evaluate its possible consequences for financial stability. “Assessing these risks will enable policymakers to improve their ability to identify vulnerabilities, better understand how geopolitical events could propagate through the financial system, and develop possible policy responses in advance. This would facilitate a rapid and coordinated policy response when needed and would strengthen the overall resilience of the financial system.”

For them institutions financial instead the indication is to “apply a combination of risk management and business diversification strategies to face geopolitical risk”. First, institutions should have a “robust capital adequacy” and “liquidity management framework” to withstand shocks, including those arising from possible geopolitical risk events. They should also have teams dedicated or use specialized services to continuously monitor geopolitical developments. “Finally – is the final advice from ECB experts – financial institutions should develop robust contingency plans so they can respond quickly to unexpected events and minimize disruptions of their operations”.

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