## Chapter 3 — Geopolitics and Financial Fragmentation: Implications for Macro-Financial Stability

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**Canonical URL:** [Chapter 3 — Geopolitics and Financial Fragmentation: Implications for Macro-Financial Stability](https://www.imf.org/-/media/files/publications/gfsr/2023/april/english/ch3execsum.pdf)

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### Key findings on geopolitical tensions and financial fragmentation
- Rising geopolitical tensions among major economies have intensified concerns about global economic and financial fragmentation.
- Geopolitical tensions are proxied by the dissimilarity in the foreign policy orientation of investing and recipient countries.
- Investing countries tend to allocate less capital to recipient countries with a more dissimilar foreign policy outlook.
- A one standard deviation increase in geopolitical tensions between an investing and a recipient country—equivalent to the diverging voting behavior of the United States and China in the United Nations since 2016—could reduce bilateral cross-border portfolio and bank allocation by about 15 percent.
- An increase in geopolitical tensions with major partner countries could cause a sudden reversal of cross-border capital flows, with the impact being notably larger for emerging market and developing economies than for advanced economies.
- Greater financial fragmentation stemming from geopolitical tensions could reduce international risk diversification opportunities and exacerbate macro-financial volatility in the longer term.

### Macro-financial transmission channels and bank-level impacts
- Geopolitical tensions affect cross-border portfolio and bank allocation through changes in the cross-border allocation of capital, international payment systems, and asset prices.
- Potential macro-financial stability risks from heightened tensions include:
  - An increase in banks’ funding costs.
  - A decline in banks’ profitability.
  - Lower credit provision to the private sector.
- These impacts are likely to be disproportionately larger for banks with lower capitalization ratios.

### Policy implications and recommended actions
- Supervisors, regulators, and financial institutions should identify, quantify, manage, and mitigate risks to financial stability stemming from a potential rise in geopolitical tensions.
- A better understanding and monitoring of interactions between geopolitical risks and “traditional” risks related to credit, interest rate, market, liquidity, and operations could help prevent destabilizing fallout from geopolitical events.
- To develop actionable guidelines for supervisors, a systematic approach that employs stress testing and scenario analysis is needed to assess and quantify geopolitical shock transmission to financial institutions.
- Based on assessments of geopolitical risks, banks and nonbank financial institutions may need to hold adequate capital and liquidity buffers to mitigate the adverse consequences of rising geopolitical risks.
- The adequacy of the global financial safety net should be ensured through:
  - Strong levels of international reserves held by countries.
  - Bilateral and regional financial arrangements.
  - Precautionary credit lines from international financial institutions.
- Given the significant risks to global macro-financial stability, countries should make utmost efforts to strengthen engagement and dialogue to diplomatically resolve geopolitical tensions and prevent economic and financial fragmentation.

### Reference to full report
- To see the full report, please refer to the English version here: https://www.imf.org/en/Publications/GFSR/Issues/2023/04/11/global-financial-stability-report-april-2023

*Source: Chapter 3 executive summary, ch3execsum*

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_Source: https://www.imf.org/-/media/files/publications/gfsr/2023/april/english/ch3execsum.pdf_