The world is facing a delicate situation with rising tensions that could trigger capital outflows and increase uncertainty. According to Kavan Choksi, a business management and wealth consultant, such developments could significantly threaten macro-financial stability. It is important to understand the potential impact of these tensions on the global economy and take necessary measures to prevent any major fallout. As countries continue to navigate these challenging times, leaders must work towards maintaining stability and promoting a sense of security necessary for continued economic growth.
As economic interdependence grows between nations, concerns about global fragmentation have only escalated in recent years. Several factors have contributed to this apprehension, including increasing geopolitical tensions, the United States and China’s ongoing trade war, and Russia’s territorial aggression in Ukraine. With the global economy more connected than ever, disruptions of trade or investment flows could have widespread ramifications. As such, policymakers worldwide need to work towards greater financial stability and cooperation to minimize the risks of economic fragmentation and protect against potential future shocks.
Global financial stability has always been a major focus for finance and investment banking experts, and financial fragmentation is a concern that cannot be overlooked. Kavan says that the implications of this phenomenon are significant, touching on cross-border investment, international payment systems, and asset prices. However, it doesn’t stop there. The far-reaching impacts of financial fragmentation also result in increased banks’ funding costs, reduced profitability, and diminished lending ability to the private sector. The knock-on effect leads to serious instability that can harm the entire financial system. These issues require serious attention from policymakers initiating solutions to financial fragmentation.
The Impact Of Geopolitical Tensions On Cross-Border Investment
With the rise of tensions between investing countries and recipient countries, it is clear that portfolio investment and bank claims are not immune to the impact of political strife. Take, for example, the recent tensions between the United States and China since 2016; current geopolitical concerns have led to a decrease of up to 15 percent in bilateral cross-border allocation of investment funds. It is unsurprising, as investment funds tend to be particularly sensitive to geopolitical tensions and are much less likely to allocate significant funds to countries with diverging foreign policy outlooks. In short, it is clear that political strife significantly impacts global investment decisions and funds.
How do geopolitical tensions pose risks to financial stability?
Geopolitical tensions are not just a matter of political strife and military conflicts- they threaten financial stability. Kavan mentions these tensions have the power to impact the economy through various channels, creating a cascade of consequences. One of the ways they can create financial instability is by imposing financial restrictions, increasing uncertainty, and triggering cross-border credit and investment outflows. It could lead to increased debt rollover risks and funding costs for banks, which will inevitably impact the interest rates associated with government bonds and reduce the value of banks’ assets.
Another detrimental effect of geopolitical tensions is their transmission to banks through the real economy. Disruptions in supply chains and commodity markets can impact domestic growth and inflation, further exacerbating banks’ market and credit losses. It puts additional pressure on their profitability and can reduce their capacity to lend money, another way the economy can suffer.
As geopolitical tensions continue to rise, the long-term economic and financial impacts could be substantial. One potential outcome of such tensions is greater financial fragmentation, which could have ripple effects throughout the global economy. It could mean limiting the ability for international risk diversification, which is critical for investors seeking to minimize risk in their portfolios. As the number of countries domestic investors can invest in dwindles, capital flows, and key economic and financial market indicators could be affected. Governments and financial institutions need to keep a close eye on these developments and take appropriate action to limit the impact of geopolitical tensions on the world economy.
Mitigating Risks: A Call to Action for Supervisors, Regulators, and Financial Institutions
Supervisors, regulators, and financial institutions must recognize and address the risks threatening our financial stability. Specifically, they must focus on the potential impact of geopolitical tensions and take proactive steps to identify, quantify, manage, and mitigate these threats.
To achieve this, gaining a deeper understanding and closely monitoring the complex interactions between geopolitical risks and more traditional ones like credit, interest rates, markets, liquidity, and operations is imperative. Doing so can prevent a potentially destabilizing fallout from geopolitical events, safeguarding our financial systems and paving the way for a secure and prosperous future.
Developing guidelines for supervisors requires a systematic approach that utilizes stress testing and scenario analysis. This approach helps assess and quantify the transmission channels of geopolitical shocks to financial institutions.
To address the increasing geopolitical risks, economies that rely on external financing must ensure they have sufficient international reserves and capital and liquidity buffers at financial institutions.
Kavan recommends that policymakers strengthen their crisis management frameworks to prepare for potential financial instability. Cooperative arrangements among national authorities are crucial for effectively managing and containing international financial crises. Effective resolution mechanisms for financial institutions operating in multiple jurisdictions should also be developed. The global financial safety net should be reinforced through mutual assistance agreements between countries to mitigate the impact of crises including regional safety nets, currency swaps, fiscal mechanisms, and precautionary credit lines provided by international institutions.
Efforts by international regulatory and standard-setting bodies, like the Financial Stability Board and the Basel Committee on Banking Supervision, should continue to promote common financial regulations and standards. It helps prevent financial fragmentation from escalating due to geopolitical risks. Policymakers must be mindful that imposing financial restrictions for national security could have unintended consequences on global macro-financial stability. Hence, given the significant risks involved, Kavan emphasizes strengthening multilateral efforts to reduce geopolitical tensions and economic and financial fragmentation.
