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A Risk Forecast for 2025: 5 Predictions

January 17, 2025 | 1 minutes reading time | By Brenda Boultwood

Chief risk officers will need to augment traditional risk assessment with a new approach to radical uncertainties.

The distinction between risk and uncertainty will be critical in 2025, which promises to take risk managers out of their comfort zone. New systemic and idiosyncratic risks will arise, impacting firms’ productivity, efficiency and growth.

Financial institutions will need to consider how to manage radical uncertainties, or risks where objective probabilities simply cannot be assigned. Peering into our crystal ball, we now offer five predictions (each a radical uncertainty) for risk management professionals in 2025:

1. Financial market stability will be threatened by groupthink in investing, especially as it applies to exchange-traded funds. U.S. equity investments continue to outperform projections, and analyst consensus points to further strong returns. ETFs have become the investment vehicle of choice for retail and wholesale investors, who are seeking low cost and liquid returns.

bboultwood-150x190Brenda Boultwood

Investors added $1.1 trillion to these funds in 2024, when many of the existing 4,000 ETFs in the U.S. were launched. New research, however, shows that ETFs threaten financial market stability through distortions in index values and volatility levels. If ETFs grow to exceed the number of underlying securities, this problem could be exacerbated.

Moreover, if there were a significant market downturn, unwinding ETFs could cause large declines in market indices and increases in volatility levels. What would be the idiosyncratic impact of such an event on your organization’s corporate treasury and pension fund investments, and how would it affect customer sentiment?

Keep in mind that the same herd mentality that’s found in equities also applies to bonds, gold and crypto. Positive correlations across virtually all domestic asset classes could escalate risks around a potential downturn.

2. Complex and increasing geopolitical threats will force firms to reconsider how they manage operational resilience. A global hybrid war between great powers is already underway, mixing elements of espionage, cyber, disinformation, trade, diplomacy and election interference with conventional military actions.

We saw plenty of evidence of this combustible concoction of geopolitical risks in 2024: Chinese hackers, for example, allegedly unleashed a massive cyberattack, dubbed the “Salt Typhoon,” on global telecommunications companies; Russian and Chinese ships, meanwhile, are suspected of cutting undersea communication cables in the Baltic Sea and Straits of Taiwan.

The idea behind such attacks is to cause chaos and harm critical infrastructure. It’s therefore vital for firms to reassess operational resilience, via gaining a deeper understanding of both their critical supply chains and their dependencies on public health, telecom and energy infrastructure.

3. Economic growth and supply-chain risk will be impacted by policy changes under the new Trump administration. This rings particularly true for policies on immigration and oil.

Are we okay with more oil drilling and commodity mining to secure supply chains? Will the U.S. allow H1B visas for highly-skilled immigrants or will this be restricted to local talent pools? Will we be open to low-skilled immigrant labor, or will we accept limits on food, maintenance, agriculture and hospital services?

Short-term, government policies may yield idiosyncratic risk for talent, the biggest asset of any organization. Longer-term, we should consider the potential effects of such policy decisions on economic growth, the supply chain, and investment and consumer demand.

4. China’s debt issues will continue to be a source of concern for global financial institutions. Debt figures for China are opaque and obscured by a puzzling stimulus package designed to keep state banks liquid.

Indeed, the balance sheets of state-owned enterprises (business are that are partially or fully owned by the Chinese government) lack transparency. But we can say that total Chinese indebtedness includes the sum of federal, provincial, and local government financing vehicles (LGFV) debt, as well as bank commercial loans (including real estate and industrial lending), special emergency country loans, swap lines, and loans to approximately 150 so-called Belt and Road countries.

A Q4 2024 report from the U.S. Government Accountability Office describes China as the “world’s largest investor in other countries,” noting that it has accumulated between $1.1 and $1.5 trillion in “outside borrower debt.” But while observing that the Belt and Road Initiative could yield short-term benefits, the report also questioned whether the opaqueness of the loan agreements China has struck with other countries (deals that cut across infrastructure, energy supplies and telecommunication) could eventually result in corruption.

“Countries receiving Chinese investments may end up with unsustainable debt that leaves them no choice but to support Chinese global goals,” the report stated. “Leaders we spoke with told us that the agreements their country made with China were often opaque. Officials were surprised by high interest rates and unsure of the exact amount their country owed.”

We’ve seen examples of what happens when countries fail to repay their debt to China. Roughly seven years ago, for instance, China took over Sri Lanka's Hambantota port. That gave China yet another strategic position for docking its naval surveillance and spy ships.

There is still much to understand about the level of sovereign indebtedness to China, particularly since questions remain about the reliability of government data. Fiscal uncertainty, moreover, is not China’s only problem. Structural headwinds – including high unemployment across age groups (especially school graduates), excess capacity and deflation – have weakened consumer sentiment.

Considering all these issues, global financial institutions must ask themselves two questions: (1) How will financial and real markets be impacted? and (2) What will it take to China-proof our organization?

5. U.S. inflation will grow, yielding more complicated strategic risks. In the U.S., we should expect moderate growth and higher inflation expectations, grounded in anticipated price increases resulting from proposed policies on immigration, taxes and trade. The Fed will back off its interest rate cuts, and the U.S. dollar will continue to strengthen to offset any trade balance impacts of import tariffs.

The net result is uncertain, but it means that customer demand and the impacts of changing government policies will become significant strategic risks. This will create idiosyncratic risks to your strategy and business objectives. 

Practical Advice

There are several approaches to operationalizing radical uncertainties. Two will seem very familiar. The first is to workshop the problem. This calls for expert development of a narrative with specific details around the idiosyncratic risks for your organization.

The second approach is the development of a root-cause analysis where the radical uncertainty is the cause of one or more idiosyncratic risks. For each risk, existing controls could be assessed to determine if further treatments to mitigate, transfer or accept the risk are warranted.

Ideally, both approaches would draw on your best internal and external experts and would ultimately lead to a consensus about the best responses.

It’s also important to remember that the negative vibes around you can drain your energy and creativity. What steps can we take, though, to mute these vibes?

To start, we can decide not to let our sentiments be influenced by the daily onslaught of media. While we wait for AI to develop the metaverse of our dreams, we can avoid social media and the worst of mainstream media. I am selecting my Substack reads from across the political spectrum. For straight-up news, it will be the BBC, Reuters, Politico, Axios and AP News.

Parting Thoughts

Frank Knight and John Maynard Keynes, two of the most prominent economists of the 20th century, believed that there are radical uncertainties that simply cannot be modeled with objective probabilities and treated as mere risks. How will financial institutions and their risk managers nurture creativity and innovation as they respond to the radical uncertainties in 2025?

CROs have traditionally thought about their internal risks, but we’ll need to expand our scope of thinking this year to the systemic radical uncertainties, particularly with respect to how these could transition to idiosyncratic risks within our organizations.

Certainly, amid today’s great rivalry between the world’s most powerful countries, distinguishing risks from uncertainties is more critical than ever. Geopolitical outcomes will need to be re-imagined, and responses in some instances will need to be improvised.

The contrarians on your team must help you think through all that appears exceptional. But you’ll also need innovators to distill these uncertainties into a set of manageable idiosyncratic risks.

This year, the grey swans will start to swim faster. The black swans, meanwhile, will need more active discovery.

The uncertainties will yield an insufficient basis for forming objective probabilities, forcing us to rely less on probabilistic judgments and more on conviction narratives that call for adaptive decision-making. At the same time, we cannot take attention away from the known risks in AI, talent management, cybersecurity and civil instability.

Bottom line, I predict a wild ride for financial institutions and their risk managers in 2025.

 

Brenda Boultwood is the Distinguished Visiting Professor, Admiral Crowe Chair, in the Economics Department at the United States Naval Academy. The views expressed in this article are her own and should not be attributed to the United States Naval Academy or the U.S. Department of Defense.

She is the former Director of the Office of Risk Management at the International Monetary Fund. She has previously served as a board member at both the Committee of Chief Risk Officers (CCRO) and GARP, and is also the former senior vice president and chief risk officer at Constellation Energy. She held a variety of business, risk management, and compliance roles at JPMorgan Chase and Bank One.

Topics: Enterprise

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