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

The IMF analysis highlights that geopolitical risk can spill over to banks through exposure to sovereign debt. A bank with large holdings of its home government's bonds faces a geopolitical shock that raises sovereign spreads. Which risk is most directly amplified by this exposure?

The sovereign-bank nexus is amplified. When sovereign spreads widen, the bank's home government bonds lose value, eroding capital and funding conditions, which in turn weakens confidence in the sovereign. Concentrated holdings strengthen this feedback loop rather than diversifying or eliminating risk.

  1. AThe sovereign-bank nexus, where weaker sovereign bond values erode bank capital and the bank's funding conditions in turn affect the sovereignCorrect
  2. BReduced operational risk from lower trading volumes
  3. CElimination of interest rate risk on the banking book
  4. DLower concentration risk through diversification across countries

Explanation

Concentrated home sovereign holdings link bank and sovereign credit quality in a feedback loop: higher spreads cut bond values and capital, weakening the bank and sovereign support. The other options misstate the effects, since concentration increases rather than reduces.

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