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This article was written by
German Public Auditor, Partner, Financial Services
German Public Auditor, Certified Tax Advisor, CQF, Partner, Financial Services
Senior Manager, Financial Services
Manager, Financial Services
Geopolitical risks have evolved into a key driver of market, credit and liquidity risks and are increasingly in focus of supervisory expectations by the ECB and BaFin. Military conflicts, sanctions, trade restrictions as well as commodity- and energy-related dependencies affect valuation levels, risk parameters and capital management through heightened uncertainty, volatility and non-linear shock mechanisms. Supervisors therefore expect an explicit consideration of geopolitical risks in models and valuation approaches, particularly where structural breaks are not adequately captured by historical time series
Against this backdrop, the ECB and BaFin increasingly call for scenario-based and forward-looking modelling approaches as well as a transparent integration of geopolitical risks into valuation processes. This includes the use of regime-based models, the consideration of risk premia in discount rates and credit spreads, and the targeted application of management overlays. At the same time, consistent embedding within ICAAP and ILAAP frameworks as well as clear governance and documentation are expected.
Geopolitical risks are increasingly acting as structural risk drivers, affecting valuation, risk measurement and capital management not only in acute stress situations but on a sustained basis. Military conflicts, sanctions, trade restrictions and commodity dependencies materialise through regime shifts, persistent risk premia as well as liquidity and funding effects.
Historically calibrated, stationary models systematically underestimate these effects. From a regulatory perspective, a scenario-based, forward-looking and governance-robust integration of geopolitical risks into risk and valuation frameworks is expected, particularly across the interaction of market, credit and liquidity risks.
We support banks in integrating geopolitical risks into risk and valuation models across the entire steering framework. This includes the development of tailored geopolitical stress scenarios for ICAAP and ILAAP, the application of regime-based and scenario-driven modelling approaches (e.g. using geopolitical risk indicators), and the derivation of consistent valuation and capital implications. In addition, we support the implementation of transparent management overlays, robust governance and documentation, and the achievement of audit readiness in line with supervisory expectations.
| 1. Geopolitical challenge | 2. Primarily affected risk types | 3. Implications & BDO approach |
| Non-linearity & regime shifts | Market, credit and valuation risks, in particular in sovereign and fixed-income portfolios | Implication: Historical volatility and spread assumptions underestimate stress phases. BDO: Application of regime-based modelling approaches (e.g. MS-VAR), definition of geopolitical stress regimes and consistent integration into VaR, stress testing and valuation models. |
| Rare but high-impact shocks (fat tails) | Market and credit risks with high portfolio concentration | Implication: Limited calibratability for extreme events. BDO: Development of geopolitical stress scenarios, structured management overlays, and clear escalation logic for senior management and supervisors. |
| Multi-channel transmission | Credit, market, liquidity and operational risks | Implication: Silo-based modelling is insufficient. BDO: Integrated scenarios linking capital market, treasury and credit implications in a consistent manner and aligning them with overall risk and valuation perspectives. |
| Data and measurement challenges | All model types, particularly market and credit risk models | Implication: Increased model and valuation uncertainty due to proxy indicators. BDO: Combination of geopolitical indicators (e.g. GPR) with exposure-based analysis (country, sector and issuer focus) and clearly documented model limitations. |
| Cascade and second-round effects | Credit, market and liquidity risks | Implication: Time-lagged effects on spreads, ratings, collateral values and liquidity. BDO: Multi-period scenarios (12–24 months) to capture spread dynamics, rating migrations and valuation adjustments over time. |
| Liquidity and funding stress | Liquidity, treasury and valuation risks | Implication: Rising funding costs, haircuts and margin calls become immediately value-relevant. BDO: Liquidity stress testing and integration of funding and liquidity premia into valuation approaches. |
| Governance and explainability | All risk types, in particular valuation and model risk | Implication: High requirements for transparency, consistency and explainability. BDO: Establishment of audit-robust governance frameworks, clear separation of model output and overlays, and consistent documentation for senior management and supervisors. |