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FRM Part II · FRM Exam Part II · Global Financial Stability Report, April 2025, Chapter 2 (Geopolitical Risk)

A risk manager at a global bank is reviewing how a sharp rise in geopolitical tension could affect the bank's balance sheet. Which description best captures a typical transmission channel from geopolitical risk to financial institutions, as discussed in analyses of geopolitical risk and financial stability?

Geopolitical shocks transmit to financial institutions mainly by repricing assets, raising volatility and risk premia, and tightening funding conditions. This causes market losses and higher funding costs. Claims that only sovereigns are affected or that volatility falls are inconsistent with how such stress typically works.

  1. AGeopolitical shocks affect only sovereign issuers and have no effect on private banks
  2. BGeopolitical shocks lower asset prices and raise volatility and risk premia, producing market losses and tighter funding conditionsCorrect
  3. CGeopolitical shocks reduce volatility because investors move to cash
  4. DGeopolitical shocks affect banks only through changes in accounting standards

Explanation

Geopolitical stress typically reprices assets, raises volatility and risk premia, and can tighten funding, so banks face market losses and higher funding costs. The other options assert no transmission or an implausible one, such as lower volatility or accounting-driven effects.

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