FIRM General Meeting

How geopolitical risks affect banks

The FIRM General Meeting 2024 was not just about formalities. Discussions focused on geopolitical risks and how banks can adapt their risk management accordingly. The second focus was on the current real estate crisis, which entails far more risks than interest rate changes and valuation.

“The question of how geopolitical conflicts affect the financial industry and how we need to prepare for them in terms of risk management will be the focus in 2024. This applies to FIRM as well as many other national and global institutions,” explained Gerold Grasshoff during his presentation at the FIRM Members’ Meeting. He cites the Institute of International Finance as an example. German supervisors have also long had the topic on their agenda. The FIRM CEO was recently a guest at the Advisory Board of the Federal Financial Supervisory Authority (BaFin) to discuss geopolitical risks.

DESCRIBING SCENARIOS, DISCUSSING SENSITIVITIES

Grashoff begins by pointing out the relevant trouble spots: China, Russia-Ukraine, Israel-Hamas, Iran, North Korea. The effects of the upcoming US elections must also be discussed in risk management. “We need to describe scenarios and discuss sensitivities so that we can prepare for the effects of these crises in risk management,” explains Grasshoff. For his analysis, he focuses on the risks that are central to the financial industry: Credit, market, liquidity, sanctions and cyber risks.

MATERIALITY OF RISKS VARIES DEPENDING ON THE CONFLICT

Geopolitical risks can be translated into specific risk types for the financial industry using various key indicators: direct risk exposure, direct risk exposure via receivables from direct investments, export volumes, role for the commodities market, via sanctions and potential cyber risks. “We have worked through this for every source of conflict,” says the FIRM CEO. “The nature and materiality of the risks differ depending on the conflict. They must therefore first be considered separately and then consolidated at the end.”

APPROACH TO ADDRESSING THE RISKS

Grasshoff first outlines in general terms how geopolitical risks can be addressed in financial institutions. The definition of a comprehensive, modern risk approach is the basis for including geopolitical developments as drivers. The second step should involve a qualitative description of the risk, including mapping the effects on the risk map. The scenarios then need to be specifically defined, the sensitivities to identified risk types calculated and finally the risk quantified. “Only then can the necessary mitigation measures be meaningfully derived,” says Grasshoff, who explains the approach in more detail using the specific example of “Credit Exposure Bank”.

SECOND-ROUND EFFECTS ARE FAR-REACHING

In addition to the further development of stress test capability in the financial industry, the focus must also be on second-round effects, which can lead to adjustments in the focus areas of politics, business and regulation. Defense capability, internal and external security and competitiveness are important keywords. “A shift in the focus of regulation towards immediate and urgent challenges could also lead to long-term initiatives and efforts, such as in the area of ESG, temporarily taking a back seat,” expects Grasshoff.

Guest lecture: Real estate markets in crisis mode

Real estate expert Jens Wilhelm was a guest at the FIRM members’ meeting. He explained why it is no longer enough in the current crisis to only pay attention to interest rate and valuation risks.

Were the risks on the real estate markets misjudged? A glance at the headlines suggests that the last few months have not been for the faint-hearted. This begs the question of whether a scenario like the 2007/2008 financial market crisis is repeating itself, or whether banks are better positioned in terms of risk management today. “The Benko case is a good example to show that the current crisis is not just about interest rate and valuation risks,” says Jens Wilhelm, who was responsible for the real estate business on the Union Investment Management Board for many years. Many investors had underestimated reputational risks, sector risks and also cycle risks and were therefore now on Benko’s long list of debts.

MARKET SHAKEOUT NOT YET COMPLETE

However, it is not just this example that reveals how fundamentally the view of risk in the real estate business needs to change. “We need a holistic approach that takes various types of risk into account,” explains Wilhelm. After all, the challenges on the real estate markets are far from over. The rapid rise in interest rates has led to considerable price corrections, which in turn has had a significant impact on loan-to-value ratios (LTV). However, it will be some time before the resulting valuation and financing gaps are closed again. “Financing conditions remain restrictive and the potential credit financing gap of EUR 36 billion is immense,” explains the expert.

Sentiment on the transaction markets is also poor, although there have been slight signs of improvement recently. “Many investors continue to wait and see. The differences in price expectations between buyers and sellers are still too great. We are still a long way from a return to normality,” says Wilhelm.

HOLISTIC RISK APPROACH IMPORTANT

The expert is certain that normality will look different on the real estate markets in the future. “Up to now, classic property and individual transaction risks have been at the forefront and were therefore also decisive for risk management,” he explains. “That will no longer be enough in the future. Risk factors such as sector and country risks or reputational risks must be taken into account just as much as concentration risks in the portfolio or operational risks in the management of a property.” Regulatory and sustainability risks must also become central elements of the assessment.

NO WIDESPREAD FIRE IN GERMANY

A current assessment of the global trouble spots shows that Germany is lagging behind the development in the USA, but that no widespread outbreak of the crisis is expected as in the 2007/2008 financial market crisis. “The volume of non-performing loans will continue to rise, but will be met with predominantly solid balance sheets and good earnings trends at the banks,” assesses Wilhelm. The situation remains difficult for project developers and builders, office properties outside of A locations and the retail sector.

Wilhelm is certain that the operational management of a property will become much more important: “In the future, performance will no longer be achieved purely through price increases. It will also be about managing and developing the portfolio sensibly. ESG readiness of real estate is also an important topic here.”

Impressions of the general meeting