RBA outlines financial stability framework to account for geopolitical risk
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The news: The Reserve Bank of Australia has released a framework for considering the impacts of the “increasingly important consideration” of geopolitical risk on financial stability, increasing the importance of contingency planning.
The context: The article aims to support financial institutions, market participants and the broader public to improve their understanding of the potential impacts of geopolitical risk.
It is intended to help entities improve contingency planning amid recent conflicts in the Middle East and Ukraine as well as “intensifying cyber attacks by state-sponsored actors”.
At a high level, geopolitical risk is defined in the article as “the potential for adverse impacts on the financial system from international tensions, including trade restrictions, sanctions, grey-zone activities and conflicts”.
The framework, released as part of the RBA’s quarterly bulletin, highlights that “the impact of a geopolitical shock is likely to differ from more conventional macro-financial stress in several ways” including by potential amplification of financial risks, novel operations challenges like insider threats or foreign interference and coordination challenges in managing a crisis when many financial and operational risks are triggered at the same time.
The framework highlights four channels in which geopolitical stress can flow into the financial system through the “behavioural responses of market participants, households and businesses”.
These channels are financial conditions, the real economy, safety and security, and international policy responses.
The five types of risks considered most relevant during a geopolitical shock, which do not map one-to-one to the transmission channels, are: credit risk, liquidity risk, operational risk, security and capacity risk, and political risk.
The Council of Financial Regulators has been working with industry to improve resilience to a range of geopolitical scenarios.
Prudential regulator APRA and corporate regulator ASIC are also integrating geopolitical considerations into their routine supervisory and oversight activities to ensure businesses strengthen their risk management practices and contingency planning.
The source: RBA paper on Geopolitical Risk and Financial Stability
