Geopolitical risks impact various aspects of banks’ operations. It is important to incorporate these risk considerations into business processes and risk assessments. With ongoing deep geopolitical uncertainties, including trade and tariff uncertainties, banks need to use scenario analysis and planning. They should have proper risk management capacities in place to address potential unexpected short-term challenges, particularly sudden changes that can materialise through many channels, such as market corrections, credit, liquidity and operational risks, but also dependencies on service providers from third countries.

Maintaining operational resilience in a fast changing and uncertain geopolitical and technological environment is a key challenge. As cyber-attack vulnerabilities grow, banks must continue investing in advanced cybersecurity measures and attracting sufficiently skilled resources. This includes exploring opportunities to use technology, including AI, to address challenges. Further efforts are also needed to address fraud risk, which has increased strongly in recent years, often facilitated technology-driven fraudulent activities as fraudsters have adopted sophisticated techniques in response to prevention of conventional attack vectors. Sanctions need to be managed properly, too.

The provision of new lending remains important going forward to support economic growth. Robust and prudential underwriting practices are key to ensuring adequate lending terms, including loan pricing, and including the consideration of rising geopolitical risks. This would not least accompany government supported investment programmes in areas like ESG related financing. Banks may also need to contribute to increased defence financing needs in Europe by financing defence-related infrastructure, R&D and innovation, as well as providing related direct corporate lending. Amid a rising bank-sovereign nexus banks also need to cautiously manage respective exposures. As NBFI links remain a key concern within increasingly volatile markets, respective exposures need to be managed cautiously. Proactive management of asset quality is important. Proper identification of potentially defaulting counterparties and adequate provisioning is on the forefront of credit risk management. Geopolitical events may also affect banks’ credit risk through direct exposures, or second-round effects affecting borrowers, and third-round effects through wider macroeconomic impacts. These may occur either simultaneously or over time via various risk types.

Market funding has lately become more challenging amid heightened volatility with higher yields in an uncertain market environment. As banks ambitiously plan to increase their market-based funding and increase debt issuance volumes, they need to use windows of benign market conditions for their issuances and be flexible while funding costs are heightened. This applies in particular for issuing covered bonds, where issuance volumes have reduced in recent months, but issuance plans are high. Although central bank funding continued to decrease, it will also be important that banks maintain sufficient eligible collateral available, if need be, including considering that rising yields or deteriorating asset quality could affect the value and the pool of eligible assets. It is also important that banks pay additional attention to liquidity management and requirements in an uncertain market environment and maintain adequately high liquidity positions, including in foreign currencies.

Although rising profits in recent years and internal capital generation allowed for ample buffers to cushion against potential upcoming challenges, capital buffers need to be managed cautiously going forward. As part of their capital planning, banks should ensure their ability to serve the economy throughout the cycle and pursue their business model while fulfilling capital requirements. Dividend payments ensure not least investor interest and confidence but also need to be managed cautiously if they contribute to a major depletion of capital buffers amid geopolitical and economic risks. While providing a useful method for managing capital ratios and increasing lending capacity, it is important that SRTs are used cautiously. This helps to prevent creating connections within the financial sector that could intensify adverse feedback loops during a significant crisis.

Banks have so far managed to keep their profitability levels well above those of the last decade despite rising pressure from lower interest rates and increasing macroeconomic uncertainty. Banks should ensure they maintain a healthy and sustainable revenue mix while managing operational expenses and impairment provisions effectively, also given the potential need for additional provisions as a result of heightened geopolitical risks. This comes in parallel to major challenges from expenses related to ongoing ICT investments as well as highly competitive pressure from other players, for example FinTechs. The introduction of CBDCs may present technological challenges as well as potential implications for banks’ profitability.

M&A should help to achieve more integration at EU/EEA level if prudential, economic and competition considerations are fulfilled. M&A is also a means to enhance and strengthen profitability, incl. through ensuring a healthy revenue mix but also revenue and cost synergies. It may also serve as a strategy to establish banks that are globally competitive and can support European businesses internationally. However, risks related to any such transaction need to be considered cautiously.

EU/EEA banks’ exposures to digital assets have so far been low. However, there seems to be increasing interest among EU/EEA banks in digital assets, with a particular emphasis on custody services. Any services related to, as well as direct or derivative own exposure to such digital assets may entail market and operational risks, for example, and require effective risk mitigation as part of EU/EEA banks’ broader risk management. It is paramount that banks follow a particularly diligent approach when doing any business in crypto markets, including having robust risk management procedures and techniques for this new kind of business.

Management of ESG related risks remains important going forward. These risks will increasingly materialise. It is essential for institutions to integrate ESG risks into their regular risk management and strategic processes to properly capture these risks as part of an integrated approach. While institutions have made progress in measuring and assessing climate-related risks and incorporating climate risk factors into credit risk models, they must also develop tools and practices that address broader environmental risks beyond those specifically related to climate.