The global economic structure is becoming increasingly complex, and trade conflicts as well as military tensions pose various risks to economies, businesses, and financial institutions. In such an environment of uncertainty, proactive risk management is more important than ever for banks. What needs to be considered, how scenarios are defined, quantified, and how corresponding mitigation measures are derived, is summarized in the current FIRM position paper.
The authors Gerold Grasshoff, Dr. Til Bünder, and Emilia Zimermann examine the potential impacts of recent developments in China, the Middle East, and the political shift in the U.S. The analysis focuses on German and European banks: How do geopolitical risks affect their credit, market, liquidity, business, sanctions, and cyber risks?
China Becomes a Challenge
Germany’s close economic ties with China are becoming a growing challenge and a potential deterioration in trade relations – up to military escalation in Taiwan – pose an immense risk to the German economy and banking industry. China is Germany’s largest source of imports and fourth-largest export market, accounting for 12 percent of German imports and 6 percent of exports. Key industries such as automotive manufacturing, chemicals, and electronics are particularly affected. The direct credit exposure of German banks to Chinese companies amounts to 36 billion euros, while an additional 220 billion euros are indirectly at risk through investments by German companies in China.
Significant Dependencies
These figures highlight the significant trade and investment dependencies between Germany and China. Should these tensions further escalate, leading to sanctions or severe trade restrictions, several German industries may face supply chain challenges, potentially impacting borrower solvency and creditworthiness. Additionally, China’s ambitions to lead in cyber capabilities by 2035 – currently associated with 45% of cyberattacks on German firms – pose growing cyber risks for Western institutions.
Minimal Financial Risks from the Middle East
In the Middle East, German banks have limited credit exposure to countries directly affected by conflict, such as Israel, Iran, and Lebanon. The Gulf States remain attractive markets for German banks through infrastructure projects like Saudi Arabia’s „Vision 2030“. However, Germany’s dependence on Middle Eastern oil has already decreased to just 6-7% which somewhat reduces the risk. Project financing and asset management services in the Gulf States could be particularly affected.
The U.S. Becomes Driver of Financial Risk
The start of the Trump administration has introduced a significant level of uncertainty for European financial institutions, and material impacts on the German economy are expected due to the "America First" policy and deregulation under the Trump administration. Protectionist measures, such as potential tariffs of up to 10 percent on European exports, could heavily burden German companies and lead to a GDP reduction of 120 to 150 billion euros in Germany.
The impact on banks is correspondingly extensive. Indirect credit risk could therefore rise significantly, as approximately 90 percent of all German companies maintain trade relations with the U.S. With regard to market price and liquidity risk, the new administration's policy is expected to trigger a rise in the dollar exchange rate and inflation in the future, which could lead to interest rate hikes in the U.S. and, in combination, to higher funding costs for German banks – the impact on European interest rate and monetary policy is then difficult to predict.
The greatest risk at present, however, seems to be that the changed course of the U.S. government could exacerbate other geopolitical crises. This applies in particular to China.
Scenario Analyses Are the Basis
Against this background, the authors recommend the establishment of an integrated geopolitical risk management system that includes regularly updated scenario analysis and sensitivity calculations. Banks should define clear escalation levels and develop emergency plans. Key measures include reducing dependence on individual markets, building alternative supplier structures, and using modern technologies to monitor supply chains. Particular emphasis is placed on investments in advanced cybersecurity systems, regular penetration tests, and training for employees. Financial institutions are advised to adjust their credit policies, simulate stress scenarios, and create risk buffers.
Important Dialogue with Regulatory Authorities
The establishment of an ongoing dialogue with international regulatory authorities and policymakers is also recommended. Additionally, financial institutions should integrate ESG criteria into their risk analyses to promote sustainable investments and long-term stability.
The main recommendation for banks is to secure their resilience and competitiveness in a volatile environment through proactive risk management, detailed scenario analyses, and the integration of geopolitical factors.
A comprehensive guide for dealing with geopolitical challenges in the financial sector can be found in the position paper, which can be downloaded here.
The Frankfurt Institute for Risk Management and Regulation (FIRM) stands for a close exchange between banks and associations, initiatives and auditing firms, the Federal Financial Supervisory Authority and the state of Hesse. One of FIRM's aims is to promote teaching and research in the field of risk management and regulation - particularly with regard to the financial sector - as well as close networking. FIRM provides new impetus in the training and further education of risk managers in cooperation with Goethe University, among others.
Visit the GBS website for an insight into the course Hot Topics in Practical Risk Management, which is co-taught by Gerold Grasshoff and Dr. Til Bünder and offered as an elective in the Risk Management & Regulation specialization of the Master in Finance.