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

A risk manager is mapping how geopolitical risk can spread across institutions through interconnections. Which statement best describes a contagion channel linking financial institutions in a geopolitical shock?

Contagion works through common exposures and counterparty linkages: when one institution suffers losses or sells assets in a fire sale, prices fall and other holders and counterparties are hit too. Losses are therefore correlated, and effects cross borders, rather than staying confined to the home country.

  1. ACommon exposures and counterparty linkages cause losses or fire sales at one institution to spill over to othersCorrect
  2. BEach institution's losses are independent, so diversification across banks eliminates systemic effects
  3. CGeopolitical shocks affect only institutions headquartered in the affected country
  4. DContagion arises only when central banks raise policy rates

Explanation

Shared asset holdings, interbank exposures and common funding sources allow stress to propagate, including through fire sales and counterparty concerns. Losses are not independent in stress, effects cross borders via global markets, and rate hikes are not required for contagion.

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