The impact of potential geopolitical shocks is likely to differ from more traditional macro-financial stress in several ways, including by generating new operational challenges for the financial system, the Reserve Bank of Australia (RBA) noted in its bulletin released Tuesday.
The RBA defined geopolitical risk as the potential for adverse impacts on the financial system from international tensions, including trade restrictions, sanctions, grey-zone activities and conflicts.
The geopolitical risk framework identified four key stress transmission channels: financial conditions, the real economy, safety and security, and international policy responses, per the report. Credit risk, liquidity risk, operational risk, security and capacity risk, and political risk are expected to be the most relevant in a geopolitical scenario, it added.
Such a shock could lead to the potential amplification of financial risks, new operational challenges for the financial system, and coordination challenges in crisis management, given the potential for multiple financial and operational risks to be triggered at once, RBA said.
Periods of heightened geopolitical risk may not be fully reflected in asset prices or volatility measures until risks crystallize, the bank said. Material geopolitical risks can build while remaining only partially priced, increasing the potential for sudden and nonlinear adjustments when conditions deteriorate, it added.
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