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3. Geopolitical turmoil
The real economy and the financial economy in Germany are highly international – making them particularly vulnerable to the effects of geopolitical tensions since international trading links can create dependencies and cluster risks. Because Germany’s financial system is highly interconnected internationally, geopolitical conflicts can damage financial stability in Germany – both directly and through second-round effects. Since geopolitical developments do not follow a set pattern, it is difficult to categorise these risks. They must therefore be considered individually. Risk models based on historical events are of limited use.
In recent years, there has been a rise in tensions and wars in many regions of the world: the situation is acute in Ukraine and the Middle East, and there is potential for escalations in the South China Sea and the Taiwan Strait. Furthermore, western states, Russia and China are increasingly organising themselves into blocks.
Trade relationships and trade flows are influenced by geopolitical interests. This could be particularly problematic if there is an abrupt change in the political perception of a trading partner and critical dependencies are affected.
Trade disputes can also emerge as a result of protectionist economic policies – particularly trade policy that is intended to damage other economies.
Consequences for the financial sector
Geopolitical turmoil may lead to an increase in the fragmentation of value and supply chains and in deglobalisation. Globally, there has been a rise in sanctions due to geopolitical conflicts.
International financial groups in particular may be forced to change their business models. The German financial industry may be affected by geopolitical turmoil in a number of ways – via subsidiaries in the particular regions or because (IT) processes or data have been outsourced to third parties and are suddenly no longer available. Some supervised companies have already revised their outsourcing strategies.1
Additional concentration risks may also arise in the area of lending, for example as a result of increased geopolitical dependency on the part of a few large borrowers. Credit risks as a result of such dependencies may also materialise for entire industries, for example if supply chain dependencies are concentrated in a country that is no longer able to meet the demands of the supply chain due geopolitical turmoil.
Geopolitical conflicts may also facilitate financial fragmentation because they lead international investors to withdraw from certain countries. This results in fewer opportunities for risk diversification and optimal capital allocation. The sudden reallocation of capital by investors may also increase uncertainty on the financial markets. Overall, geopolitical uncertainties may place an additional burden on the financial markets.2
BaFin's line of approach
- BaFin is continuing to closely monitor the geopolitical situation and is investigating the potential impacts on the German economy alongside the knock-on effects on German financial institutions.
- For example, BaFin is assessing whether the loans issued by certain financial institutions are concentrated in particular regions, industries or companies that are affected by difficult geopolitical circumstances.
- The same applies to insurers and reinsurers. BaFin aims to learn which insurers are affected and how they are affected, for example by developments in regions affected by war and crises, terror events, political decisions such as sanctions or measures to limit market access, major disturbances in value chains or loss events in the area of cyber security and communications security. This enables BaFin to identify supervised companies that are highly exposed.
- Furthermore, BaFin is increasing its contact with market participants and other relevant bodies, such as audit bodies, so that it can better assess risks in the financial sector. BaFin takes these findings into account in its supervisory practice, for example through increased monitoring or inspection campaigns at certain institutions.
More articles
Risks in BaFin's Focus 2024
Foreword by the President
Main Risks in BaFin’s Focus
1. Risks arising from significant increases in interest rates
2. Risks arising from corrections on the real estate markets
3. Risks arising from significant corrections on the international financial markets
4. Risks arising from defaults on loans to German companies
5. Risks arising from cyberattacks with serious consequences
6. Risks arising from inadequate money laundering prevention
7. Risks arising from market concentration due to the outsourcing of IT services
Trends
1. Digitalisation
2. Sustainability
