The world economies are facing a Gordian knot of challenges right from the US-China trade war to the Russia-Ukraine conflict, a turmoil of geopolitical change has led us to ask the question, ‘What impact will it bring on the financial sector?’ The resulting fragmentation of the global economy could increase financial stability risks, reducing cross-border investments, asset prices, payment systems and banks’ ability to lend. These hostilities are serving as a threat to the global economic outlook. Geopolitics also has profound implications for the more traditional risks from macroeconomic outcomes, with which bank supervision is usually concerned.
Financial stability is the talk of the town after the recent banking upheaval, the failure of Silicon Valley Bank and Signature Bank in the U.S. and Switzerland’s forced sale of Credit Suisse to rival UBS.
Impact of US-China trade tensions on the Global Economy
The trade tensions have antagonistically distressed both buyers and manufacturers of both nations. The trade tensions have contributed to a slowdown in global economic growth, as businesses have become more cautious and less willing to invest due to uncertainty about the future of trade relations.
The US and China have imposed tariffs on each other’s goods, which has led to higher prices for consumers and businesses. Accordingly, leading to a reduction in the volume of trade between the two countries, as well as other countries that have been affected by the trade tensions.
As tariffs on goods increase, companies have to pay more to import raw materials and other goods from China, which in turn accounts for higher production costs for companies that rely on Chinese imports, which can reduce their profitability.
It has also disrupted supply chains for many companies, as they have to look for alternative sources of raw materials and other goods. Leading to delays and higher costs for many companies, which can have a ripple effect throughout the economy.
Shifts in global trade patterns are observed, as companies look for alternative sources of goods and try to reduce their dependence on China. As a result, this has increased trade between other countries, as well as increased investment in countries that are not affected by the trade tensions.
Consequences of Russia-Ukraine Hostilities on global financial services
Any conflict between two major world powers has the potential to create market volatility. As investors become uncertain about the stability of the global economy, they may pull their investments out of riskier assets, such as emerging market currencies, which can cause significant fluctuations in the financial markets.
Ukraine is an important transit country for Russian gas and oil exports to Europe. If the conflict leads to supply chain disruptions, it can cause a shortage of energy supplies thus resulting in higher prices for consumers and businesses in Europe.
Cybersecurity threats can arise during times of political and military tensions. If hackers were to target financial institutions or systems, it could lead to significant disruptions in the financial services industry.
The conflict between Russia and Ukraine has the potential to impact the broader geopolitical landscape, leading to increased geopolitical risk. This can create uncertainty for businesses and investors, leading to a decrease in investment and economic growth.
Some of the major issues during the geopolitical upheaval in the financial sector
The first impact would be on cross-border investment. The divergence in countries voting behaviour in UN General Assembly acts as a major factor in the cross-border portfolio and bank designations. So, for example, an increase in the tension between China and US, to be precise, between an investing and a recipient country lessens the comprehensive bilateral cross-border allocation of portfolio investment. Investment funds are susceptible to any geopolitical disturbance leading to reduced cross-border allocations, especially those countries that have deviating visions on foreign policy.
Secondly, there is uncertainty concerning financial cohesion. Financial restrictions, distrust among countries and investment outflows influenced by these tensions will affect banks’ funding capabilities. Furthermore, an increase in the interest rate on government bonds will cut down the banks’ assets. These hostilities are propagated to banks in terms of the real economy
Supply chain and market disruptions could leave an adverse effect on price inflation and GDP, thereby reducing banks’ profitability and capitalization. Banks may become less willing to take risks as a result of the stress, which would force them to reduce lending and further impede economic growth.
Banks in emerging markets and developing countries, as well as those with lower capitalization ratios, will likely have a disproportionately higher cumulative effect as a result of the financial and real economy channels consuming one another.
Hence, increased financial fragmentation brought on by geopolitical tensions may also disrupt capital flows and important financial and economic market indicators by restricting alternatives for diversifying risks worldwide, such as by lowering the number of nations in which domestic investors are permitted to invest.
Steps to Mitigate Risks on Banks During Geopolitical Stress
Amidst all this turmoil major steps need to be taken to assure stability in the banking sector. Some of them include-
Conduct regular risk assessments: Banks should conduct regular risk assessments to identify and assess potential risks arising from geopolitical tensions. This can help them develop appropriate risk management strategies.
Enhance due diligence: Banks should enhance their due diligence procedures to ensure that they understand the risks associated with customers, transactions, and counterparties. This can include enhanced KYC (Know Your Customer) procedures and ongoing monitoring of transactions.
Strengthen compliance and regulatory framework: Banks should strengthen their compliance and regulatory framework to ensure that they comply with relevant laws and regulations. This can help them avoid sanctions and penalties that may be imposed due to non-compliance.
Develop contingency plans: Banks should develop contingency plans to prepare for potential disruptions in the banking system due to geopolitical tensions. This can include developing alternative payment channels and establishing backup systems to ensure business continuity.
Collaborate with stakeholders: Banks should collaborate with relevant stakeholders, such as regulators, industry associations, and other banks, to share information and best practices. This can help them stay up-to-date with the latest developments and mitigate risks more effectively.
Invest in technology: Banks should invest in technology to enhance their risk management capabilities. This can include using artificial intelligence and machine learning to detect potential risks and monitor transactions in real time.
Monitor geopolitical developments: Banks should monitor geopolitical developments and assess the potential impact on the banking system. This can help them take proactive measures to mitigate risks and minimize the impact on their operations.
By implementing these steps, banks can mitigate the risks arising from geopolitical tensions and ensure the stability and resilience of the banking system.
Conclusion
Geopolitical tensions can pose significant threats to the banking industry. Heightened geopolitical risks can lead to increased volatility in financial markets, which can negatively impact the banking sector’s profitability and stability. Banks may also face risks related to sanctions, regulatory changes, and the potential for cyberattacks and other security breaches. To mitigate these threats, banks should have robust risk management strategies in place that consider various scenarios and potential impacts on the business. They should also maintain close relationships with regulatory authorities and intelligence agencies to stay informed about potential risks and adjust their strategies accordingly. Additionally, investing in cybersecurity and data protection measures can help banks reduce their vulnerability to potential cyberattacks. Overall, proactive risk management and preparedness are key to mitigating the threats that geopolitical tensions can pose to the banking industry.
Article by Tamanna Shaikh
