Geopolitical Risk in Banking: From Blind Spot to Boardroom Priority
The geopolitical environment has become an increasingly disruptive factor for global financial institutions. Banks are now operating in a world marked by war in Europe, escalating Middle East tensions, decoupling of major economies, energy and food insecurity, sanctions volatility, and cyber warfare. All these factors contribute to geopolitical risks being not only a concern for government departments - it is an enterprise risk with board-level implications for the financial services industry.
Despite this shift, banks continue to struggle with how to measure and manage geopolitical risk. There is no widely accepted methodology for quantification, traditional risk models are ill-equipped to capture complex macro-political drivers, and geopolitical forecasting remains inherently uncertain. In the 21st century, where financial firm’s operations and locations span the globe, the banking system is significantly exposed to geopolitical shocks via sovereign, trade, funding, and counterparty channels, yet such risk(s) is often challenging to quantity and thus integrate into the overall risk management frameworks.
If that is the case, how can banks move from geopolitical risk awareness to structured quantification and integration within their risk management architecture? In our opinion, the answer lies in adopting a structured taxonomy, leveraging empirical evidence, building forward-looking scenarios, and embedding geopolitical risk into core frameworks like ICAAP and stress testing to help banks better anticipate, prepare for, and respond to this risk category.
Finally, banks must not only acknowledge geopolitical risk as material and relevant, they must also understand how such a risk impacts their operations, financial statements (balance sheets and income statements), and business strategy, and take steps to translate abstract uncertainty into actionable insights.
The Complexity of Quantifying Geopolitical Risk
For banks, the challenge of modelling geopolitical risk lies in its inherent ambiguity and unpredictability. Unlike credit or market risk, there is no common standard across the financial sector, which makes it easy to blur the lines between country risk, sovereign risk, ESG considerations, and broader geopolitical drivers such as regime change, interstate conflict, or trade decoupling. Historical precedents provide little guidance, since most geopolitical shocks are context-specific and rarely follow repeatable patterns.
The way these shocks spread through the financial system adds further complexity. Their impact is rarely straightforward: a single event can simultaneously affect sovereign ratings, currency movements, commodity prices, operational continuity, and even trigger litigation risk. Markets themselves can act as amplifiers, turning localised disruptions into systemic crises. As noted in the European Banking Authority’s “Macro-financial scenario for the 2025 EU-wide banking sector stress test”, geopolitical tensions often interact with asset valuation bubbles, cyber vulnerabilities, or energy supply shocks, creating stress that reverberates across the entire system.
To cope with this landscape, banks need more than general awareness. They require frameworks capable of transforming political ambiguity into structured, decision-useful inputs tools that can translate uncertainty into actionable insights and prepare institutions for an environment where regulators and investors are demanding clearer answers.
Rising Expectations from Supervisors and Stakeholders
Regulators are sharpening their focus on geopolitics, and banks are increasingly expected to show how they would withstand shocks that were once treated as outliers. In the eurozone, the European Central Bank has been explicit. In its April 2025 Macroprudential Bulletin, it warned that geopolitical events can trigger adverse economic developments and even threaten financial stability. That conclusion has already been put into practice: the ECB’s 2025 EU-wide stress test includes a bespoke adverse scenario described as “an aggravation of geopolitical tensions leading to depressed global growth.”
Across the Channel, the Bank of England has taken a similar approach, planning stress tests that capture the risks of global trade fragmentation and sovereign debt strains. Meanwhile in Washington, the Federal Reserve’s 2025 Financial Stability Report listed risks to global trade as its top vulnerability and placed geopolitical shocks among the ten most frequently cited threats to markets over the next 12 to 18 months, highlighting potential damage to investor confidence and volatility in capital markets.
Supervisors are not the only ones pressing the issue. Investors and clients are aware of the implications also. BlackRock’s July 2025 Geopolitical Risk Dashboard judged six out of ten major risks to have a “high” likelihood, with global trade protectionism topping the list. A BCG survey released earlier this year reached a similar conclusion, finding that 51% of investors ranked geopolitics among their top three concerns.
This convergence of regulatory scrutiny and market anxiety has created a tipping point. The pressure is on to formalise management approaches, build consistent methodologies, and demonstrate resilience in the face of increasingly unstable global politics.
Bridging the Gap: Towards Practical Quantification
Turning geopolitical awareness into actionable risk management requires a structured, data-driven approach that banks can integrate into their existing frameworks. Institutions that are furthest ahead tend to follow a common pattern. They begin by defining a clear taxonomy of geopolitical risks (categories such as state conflict, sanctions regimes, political instability, or ideological divergence) and then linking these categories directly to business lines, legal entities, and jurisdictions. This ensures that political threats are not treated in the abstract way, but are linked to specific parts of the organisation for further assessment.
From there, exposure mapping becomes essential. Banks are increasingly charting their cross-border dependencies, identifying where sovereigns, counterparties, trade routes, or supply chains leave them most vulnerable. Many, supplement this work with insights drawn from academic studies and international policy research, recognising that internal data alone cannot capture the full scope of such a global risk.
Scenarios provide the next layer. Institutions are developing libraries of possible crises, building narratives around real-world flashpoints such as tensions in the Taiwan Strait or supply disruptions in the Middle East. These narratives are then translated into quantitative overlays: credit default swap spreads, sovereign downgrades, exchange rate swings, or counterparty loss estimates, calibrated carefully against the bank’s own balance sheet and risk profile.
The implications become clear in a hypothetical case. Consider a mid-sized Luxembourg-based bank with heavy counterparty exposures in the United States, operational reliance on capital markets infrastructure in both New York and Frankfurt, and custody services linked to Chinese assets. A rupture in the US-China relations, marked by technology decoupling, sanctions escalation, and a cyberattack on European clearing systems, could create simultaneous shocks on multiple fronts. Markets might tumble as Chinese equities plunge and US technology stocks retreat, while foreign exchange volatility sends the euro-dollar pair into sharp swings. At the same time, a cyberattack could compromise SWIFT access in Luxembourg, cutting off critical operational lifelines, while sanctions could leave the bank exposed to compliance breaches and reputational fallout tied to Chinese corporates. The financial consequences, ranging from inflated risk-weighted assets and liquidity pressures caused by settlement delays to shortfalls in capital buffers, would feed directly into ICAAP overlays, Recovery Plans, and liquidity stress calibrations.
The banks that prove most resilient are those that integrate these lessons into their existing governance. Geopolitical risk is now being embedded into ICAAP identification and capital planning, as well as liquidity analyses, reputational registers, and operational scenarios. Risk appetite statements are being adjusted to reflect explicit tolerances for politically sensitive exposures. And beyond the numbers, institutions are testing their organisational readiness. Some are running full-scale geopolitical simulations, inspired by the European Banking Authority’s 2025 guidance on resolution exercises, with Board members directly involved in decision-making under conditions of strategic and reputational stress.
This change reflects a deeper transformation: geopolitical risk has transitioned from a secondary concern to an integral component of enterprise resilience.
From Reactive to Proactive
Geopolitical risk has become a strategic and supervisory imperative. International banks face quantifiable transmission of geopolitical alignment shifts into funding, lending, and capital flows. Meanwhile, regulators from the ECB to the Fed are embedding geopolitical stressors into core supervisory tools.
Banks that act now, by developing taxonomies, exposure maps, and scenario engines, will meet the regulatory expectations as well as enhance their strategic agility. Quantifying the unquantifiable emphasises preparation over perfection.
At Avantage Reply, we stand ready to help financial institutions design, implement, and mature their geopolitical risk frameworks, guiding them in building proactive strategies, embedding risk awareness across operations, and strengthening their ability to respond swiftly to emerging geopolitical challenges.
This article was originally published in the Agefi Luxembourg Newspaper - September 2025 edition