ECB Expectations on Geopolitical Risk Management – Implications for Governance and Risk Frameworks

ECB Expectations on Geopolitical Risk Management – Implications for Governance and Risk Frameworks


The ECB has emphasized the importance of integrating geopolitical risks into banks' governance, Internal Capital Adequacy Assessment Process (ICAAP), Internal Liquidity Adequacy Assessment Process (ILAAP), credit risk frameworks, and other risk categories towards the end of 2024. These expectations align with the EU’s regulatory priorities to enhance financial stability amid heightened geopolitical uncertainties and complement the forthcoming Capital Requirements Directive VI (CRD VI) and Capital Requirements Regulation III (CRR III).

As geopolitical risks become more pronounced, financial institutions must ensure their integration into risk management frameworks. Compliance with ECB and European Banking Authority (EBA) expectations and a robust economic view on the risk driver and its themes are crucial to maintain financial stability and operational resilience. By adopting structured risk assessment methodologies and refining scenario planning, institutions can optimize their navigation through geopolitical uncertainties and strengthen financial stability.

This paper highlights our view on key regulatory expectations, best practices and learnings from industry experts in- and outside the financial services sector and practical implications from current projects.

Our Financial Services Risk Experts are ready to serve you in optimizing existing risk management frameworks, measurement approaches and steering as well as controlling and reporting processes to ensure a risk- and portfolio-specific inclusion of geopolitical risk considerations. Our goal is to provide hands-on and pragmatic solutions to support your navigation through challenging times. Part 1 of our series focuses on an overview which will be the basis for a dedicated workprogramme we recommend banks’s to implement.

 

  • Geopolitical risks must be embedded into strategic decision-making and governance structures. The operationalization is guided through defined risk appetite thresholds, enabling management interventions and corrective actions in case of material deviations.
  • The risk inventory is key! An enhancement of the qualitative and (if possible) quantitative analysis is a necessary entrance point to analyze the status quo of the impact of geopolitical risks across risk types.
  • The derivation of playbooks for the most relevant geopolitical risk themes should be one focus area as active monitoring and management in crisis constellations is essential. Hereby, we recommend to leverage lessons learned from most recent or historical crisis constellations to optimize the forward looking crisis management.
  • Institutions must incorporate scenario analyses into their business strategies to assess the impact of geopolitical disruptions on operations and financial stability.
  • Compliance with the forthcoming CRD VI and CRR III ensures that geopolitical risks are fully integrated into risk frameworks and capital planning.
  • Alignment with regulatory disclosure frameworks, such as Pillar 3, is essential for transparency and regulatory compliance.
  • To enhance board-level risk governance, geopolitical risks must be linked to risk appetite (e.g. via an integration in risk appetite setting considerations) frameworks and governance reporting, ensuring compliance at strategic levels and facilitating consistent monitoring of risk factors in decision-making processes.
  • Data collection must be based on geopolitical risk materiality assessments, allowing flexibility in terms of granularity based on exposure levels and regions.
  • The Geopolitical Risk (GPR) Index measures global geopolitical risk based on media references. The ECB has also developed indicators to assess banks' vulnerabilities to geopolitical risks (see annex).
  • The use of proxies is allowed when data is unavailable; however, reliance on proxies should decrease over time as data quality improves.
  • Specific risk metrics, especially for banking sectors exposed to high-risk jurisdictions, need continuous refinement to enhance transparency.
  • Scenario-based analysis should complement traditional risk models to reflect the impact of geopolitical risk drivers on financial stability.
  • Geopolitical risks shall be explicitly factored into ICAAP scenario design, ensuring capital adequacy assessments integrate exposure to sanctions, trade disruptions, and macro-financial instability.
  • Scenario-based stress testing must include geopolitical shocks to assess financial stability under adverse geopolitical conditions.
  • ICAAP models should incorporate capital buffers tailored to geopolitical vulnerabilities.
  • Capital planning needs to consider increased funding costs and market volatility resulting from geopolitical tensions.
  • Geopolitical risks needs be included in liquidity stress testing scenario design to prepare for potential short-term liquidity and mid-term funding shocks.
  • Concentration risks should be assessed in the context of geopolitical instability, particularly for reliance on specific regions or counterparties.
  • Banks should develop contingency plans to manage liquidity constraints arising from geopolitical disruptions, incl. clear escalation trigger and reporting lines that also reflect political conflicts by leveraging reporting lines through other countries / functions of the bank.
  • ILAAP frameworks should incorporate geopolitical event-driven market disruptions into liquidity risk scenarios.
  • Geopolitical risks should be explicitly considered in provisioning models to reflect potential borrower defaults and asset quality deterioration.
  • Large institutions should apply model overlays on a component level to account for geopolitical uncertainty.
  • Adjustments to collateral valuation should be implemented, ensuring haircuts reflect geopolitical vulnerabilities.
  • Forward-looking information must incorporate PD and LGD shifts as well as CCF changes, aligning with evolving geopolitical risk factors.
  • Sectoral provisioning should follow a collective approach, considering heightened exposure in industries such as trade finance and energy.
  • Geopolitical risks impact asset quality based on exposures, i.e. import-heavy SMEs and corporates with intercontinental ties face may immediate pressure, while locally focused SMEs may also be affected if persistent shocks drive domestic inflation. Provisioning models should account for these risks by adjusting for potential borrower defaults and asset quality deterioration.
  • Geopolitical factors must be embedded into credit underwriting, risk classification, and portfolio management.
  • Materiality assessments should analyze the financial impact of geopolitical risks on counterparties, sectors, and regions.
  • Banks must assess exposure to geopolitical hotspots and adjust their lending strategies to mitigate potential risks.
  • Institutions must demand forward-looking contingency plans from clients in high-risk sectors, ensuring transparency and preparedness.

Materiality Assessment & Data Infrastructure

  • Geopolitical risk materiality must be assessed consistently across ICAAP, ILAAP, and overall risk frameworks. 
  • Continuous monitoring and refinement of geopolitical risk indicators are essential for transparency. 
  • Dedicated risk committees should oversee geopolitical exposure assessments and regulatory compliance.

Credit Risk & Stress Testing

  • Banks should validate and if necessary establish forward-looking risk assessment models that incorporate geopolitical scenarios. 
  • Enhanced credit screening and due diligence processes should be applied to counterparties in high-risk regions. 
  • Regulatory stress testing must incorporate geopolitical factors, ensuring resilience under various scenarios.

Liquidity Risk & Scenario Planning

  • Liquidity risk frameworks should include stress-test methodologies that simulate geopolitical disruptions. 
  • Banks must align risk mitigation strategies with ECB and EBA supervisory expectations.
  • Scenario-based models should assess the impact of geopolitical risks on funding and capital buffers.

How BDO will support your Institution

  • Risk Inventory, Risk Framework and Risk Appetite: Conducting a 360 degree analysis throughout the enterprise risk management and enhance the current risk inventory and risk frameworks to derive comprehensive materiality assessments which feed into the determination of the risk appetite. 
  • Development of Geopolitical Scenarios: Tailored risk scenarios to assess potential impacts on capital adequacy and financial stability.
  • Implementation of ICAAP / ILAAP-aligned Stress Testing: Conducting stress tests that incorporate geopolitical shocks.
  • Set Up of Playbooks for active Monitoring and Management: Conduct lessons learned sessions from crisis events and set up / optimize business continuity / contingency playbooks.
  • Optimization of Risk Models & Expert Advisory: Enhancing risk models to accurately reflect geopolitical risks and providing expert guidance on implementation strategies.


Annex: ECB Indicators for Geopolitical Risk Assessment

To support the integration of geopolitical risks into financial institutions’ risk management frameworks, the ECB has developed specific indicators that allow for a structured assessment of geopolitical risk exposure:

  • Geopolitical Risk (GPR) Index

The Geopolitical Risk (GPR) Index is a global measure of geopolitical uncertainty based on media references. It evaluates geopolitical tensions by analyzing news reports and categorizing them into risk-driving events. This index serves as a broad indicator of geopolitical stress, influencing market volatility, economic sentiment, and financial stability.

  • Bank Exposure-Weighted Geopolitical Risk Index

The Bank Exposure-Weighted Geopolitical Risk Index is an ECB-developed metric that builds on the GPR Index but is tailored to individual banks. It assesses a bank’s specific exposure to geopolitical risk by weighting geopolitical threats based on its geographical asset distribution.

Banks with significant operations in high-risk regions receive higher index values, indicating greater vulnerability. This risk-weighting approach allows institutions to refine their capital adequacy, stress testing, and scenario planning to better reflect geopolitical uncertainty.