In an increasingly confusing world, non-financial risks for financial institutions are on the rise. Gerold Grasshoff, CEO of the Frankfurt Institute for Risk Management and Regulation (FIRM), describes the four biggest challenges as geopolitical developments, sustainability and cyber risks and, finally, reputational risks in connection with disinformation. "Geopolitical issues are not new, but have become much more prominent, especially with regard to China, Russia and Iran," says Grasshoff.

This in no way means that credit and interest rate risks, for example, are no longer relevant. However, the methods for defining, measuring and quantifying such financial risks are more advanced than in the case of non-financial risks. Banks have also come a long way in terms of defence against money laundering and the prevention of sanctions evasion.

Although the dangers posed by non-financial risks have been a concern for banks for some time now, their importance continues to grow, says Grasshoff. "The losses that financial institutions have had to deal with over the past ten years have mainly occurred in the area of non-financial risks: Money laundering, sanctions evasion and the significant penalties associated with it."

In addition, there are now geopolitical risks that characterise the lending business of banks, for example. The tensions between China and the USA, Beijing's threats against Taiwan, Russia's war of aggression against Ukraine, the Gaza war triggered by Hamas' massacre of Israelis and Iran's support for terrorist organisations such as Hamas and Hezbollah: All of this could be seen as part of a global conflict between democracies and autocracies.

"Internationally active institutes need to consider the fact that the conflict between autocratic and liberal-democratic systems will continue and may unfortunately intensify," warns Grasshoff. "This needs to be thought through and mapped out in scenarios. Because the implications can be considerable." In his experience, such questions are already being discussed in banks, and not only in internationally active institutions, but also in those focussed on Germany that count export-oriented companies among their customers.

The FIRM CEO also mentions a possible decoupling of economic areas, a decoupling for which it would be necessary to prepare in the worst-case scenario. "Nobody wants a confrontation with authoritarian systems, but it cannot be ruled out, as Russia's attack on Ukraine shows. The possibility of decoupling cannot be ruled out, as was the case in the conflict between systems up to 1989. Unfortunately, the issue is back."

Environmental, social and governance (ESG) aspects have been somewhat superseded by geopolitical considerations in risk management, observes Grasshoff. The USA, for example, has made it clear that sustainability criteria will be put on the back burner if competitiveness suffers as a result. Priorities would then lie elsewhere in view of the systemic competition with China.

Grasshoff welcomes the desire to internalise external effects, such as pricing the costs of environmental pollution. However, the question of how this can be achieved is not answered everywhere in the same way as in Germany. Germany and Europe have decided to take the route of regulation in order to have the banks increasingly finance those sectors that operate in a more climate-friendly manner and other sectors less so.

The ECB has appointed banks as "change agents" to bring about changes in the financing of the economy until it is CO2-neutral. "It can be done that way," says Grasshoff. "The question is how successful it is, given that only 5% of companies have a transformation plan and that only 50% of the emissions data is reliably available to us."

It remains to be seen whether the regulation-based approach in Europe will lead to a solution to the problem. The USA is pursuing a different approach. The Americans are focussing on innovation and engineering skills such as carbon capture, which pulls CO2 out of the atmosphere. "They subsidise this and hope that it will promote the likelihood of innovation and ultimately market penetration," explains Grasshoff.

In any case, the internalisation of external effects is a mammoth task. The means and solutions must be debated openly and without ideology, warns the FIRM CEO, who also bemoans the narrowing of the topic of ESG to climate, global warming and man-made CO2 emissions. On the one hand, this harbours the risk of disregarding possible solutions and, on the other, of incurring reputational risks if regulations are disregarded.

"My recommendation is to take a holistic approach to ESG instead of narrowing the topic down to a debate purely about CO2, to implement regulation slowly and to take a very close look at how things can change," suggests Grasshoff. There also needs to be an ongoing debate about what is the best way to preserve biodiversity. "We must not ignore other aspects such as social security or energy supply," he points out.

Aside from the hot topics of geopolitics, sustainability and ever-increasing cyber risks, risk managers are increasingly concerned about the threat of disinformation. According to Grasshoff, how to deal with false or misleading texts, audio recordings, images and videos is also a social task, as democratic opinion-forming processes are being manipulated. "If a majority opinion emerges very quickly and it is only an apparent one because the debate has been shortened by disinformation or has not taken place, then democratic structures are vulnerable. It would be naïve to believe that this would not be reflected in autocratic systems," he warns.

Disinformation can produce perceptions that do not exist or are not relevant. And how social media in particular overlaps national debates is not yet sufficiently understood. "This is highly dangerous for companies and entire societies," warns Grasshoff. The members of the FIRM network are dealing with questions like these, he reports, but they are still at the very beginning of analysing fake news and the resulting reputational risks.

According to the World Economic Forum's Global Risks Report 2024, the majority of more than 1,400 risk specialists, politicians and managers surveyed consider misinformation and disinformation generated by artificial intelligence to be the greatest short-term risk. The report was presented just recently.

This year, FIRM will also devote itself to the task of explaining the societal relevance of risk management. "It is an attempt to add risk to the topics return and growth in order to ultimately create longer-term, more sustainable value creation. Companies cannot grow profitably if they are not aware of the risks they are taking."