Geopolitical Volatility and Financial Resilience: Considerations for Valuation and Credit Risk

The following article first appeared on the Finance Dublin website in July 2025

Conflicts such as the Israel-Hamas war and the ongoing conflict in Ukraine, coupled with protectionist trade policies from the United States, have had observable effects on fund flows, asset pricing, risk appetite and modelling assumptions.

The geopolitical environment since late 2023 has been marked by interrelated stress. Escalation in the Middle East, ongoing warfare in Eastern Europe and rising global trade tensions. These factors have contributed to energy and commodity price volatility, increased sovereign and corporate credit spreads, greater dispersion in fund performance across geographies and asset classes, shifts in supply chain planning and investor positioning.

The persistence of these events has introduced a new level of increased uncertainty, which will no doubt prompt financial institutions to reassess underlying assumptions in both valuations and credit models.

Despite geopolitical headwinds, 2024 recorded resilient inflows into long-term European funds, including €459.6 billion in net new money. This momentum, particularly in Q4 2024, was supported by improving inflation trends and more dovish monetary policy expectations.

Investors have responded to geopolitical events with bouts of derisking, shifting capital towards passive strategies and money market instruments. As an example, periods surrounding heightened tensions in Gaza and new U.S. tariff announcements witnessed temporary spikes in volatility index and option hedging volume, flows out of emerging market funds, and selective rebalancing into energy, defence and gold-linked funds. These movements indicate that while market participants may not be abandoning risk assets altogether, they are increasingly positioning around geopolitical tail risks as core portfolio considerations.

Some of the ways in which these risks are being captured in valuation models are through the increased use of geopolitical risk premiums. Higher discount rates to cash flow models for companies with material exposure to politically sensitive regions or global trade flows. Scenario models now include trade disruption and sanctions risk. There are also sector-specific sensitivities to be considered, including the energy sector. This more granular application of geopolitical sensitivity reflects an evolving best practice in asset valuation. No longer treated as low-probability, high-impact events, geopolitical risks are now integrated as dynamic elements of market pricing.

Geopolitical risks have had material implications for credit modelling assumptions in the banking sector. Traditional credit models are being supplemented with overlays to reflect country risk and sanctions exposure, trade and earnings disruptions. Elevated input costs due to geopolitical factors (particularly energy and food) are increasing credit stress in vulnerable sectors. These developments have led to increased internal stress testing activity.

The European Central Bank’s 2023 and 2024 supervisory cycles placed growing emphasis on banks' exposure to geopolitical risk, including the effects of deglobalisation. The key takeaways included:

• Institutions are expected to incorporate geopolitical scenarios and adverse stress testing in their ICAAP frameworks.
• Supervisors have flagged that under-recognition of such risks may constitute a material model risk requiring remediation.
• The ECB’s 2025 exploratory stress test on counterparty credit risk explicitly includes geopolitical variables such as supply chain shock propagation and non-bank financial intermediation sensitivity.
• The Central Bank of Ireland has reiterated the need for proactive risk identification, conservative provisioning, and robust capital buffers in light of global fragility.

Financial institutions have increasingly adopted scenario planning techniques to prepare for a range of geopolitical outcomes. This has included tailored macroeconomic stress testing for conflict-related inflation and recessionary shocks and simulated funding and liquidity stress events tied to market dislocation or capital flight.

Asset managers will need to refine internal valuation committees and governance processes to incorporate geopolitical materiality assessments. These are supported by enhanced sensitivity analysis and liquidity management protocols.

Geopolitical instability has emerged as a persistent structural force with far-reaching implications for financial services. For asset managers, it demands renewed scrutiny of valuation inputs and fund exposure mapping. For banks, it necessitates rethinking credit risk frameworks, stress testing design, and exposure controls. In both cases, the response must go beyond short-term risk aversion. Institutions should adopt a forward-looking approach rooted in strategic resilience, data-informed scenario modelling, and proactive governance. In an era where financial markets are increasingly shaped by political realities, the ability to quantify, adapt to, and ultimately absorb geopolitical shocks will define the credibility and success of valuation and credit risk practices going forward.

This article, written by Forvis Mazars Head of Quantitative Solutions, Cian Higgins, first appeared on the Finance Dublin website in July 2025