Why Record-High Conflicts Threaten The Global Banking System

Five Channels That Threaten Financial Stability

The academic and regulatory literature has long acknowledged that armed conflicts destabilize financial systems. What is new—and what demands immediate attention from the Basel Committee, the Financial Stability Board (FSB), and national legislatures—is the simultaneous activation of multiple destabilization channels at unprecedented scale.

Sovereign Debt and Non-Performing Loan Cascades

Physical capital destruction, mass displacement, and government fiscal reprioritization toward war economies degrade bank loan portfolios rapidly. In active conflict zones, commercial debt deteriorates into non-performing loans (NPLs) faster than any peacetime credit cycle. Domestic banks holding sovereign bonds in affected states face dual pressure: falling bond prices and capital adequacy shortfalls that can trigger liquidity events. Sudan, Ukraine, and Haiti represent three distinct NPL risk archetypes currently playing out simultaneously.

Commodity Volatility and Margin Compression

The weaponization of trade chokepoints—most visibly in the Strait of Hormuz, Red Sea and Bab al-Mandab Strait—produces supply-side inflation that is qualitatively different from demand-driven price increases. Central banks cannot easily address supply shocks through interest rate tools without inflicting collateral damage on credit demand. The result could be an extended period of elevated benchmark rates that compress bank net interest margins (NIMs) and weaken loan origination. The Red Sea disruption alone has added an estimated $1 million per vessel in rerouting costs, with cascading effects on commodity pricing across agricultural and energy sectors.

Sanctions Complexity and AML/CTF Overhead

Each new interstate conflict triggers a new sanctions architecture. The Russia-Ukraine war alone generated over 12,000 individual and entity sanctions designations across Western jurisdictions. Eight simultaneous interstate wars means eight parallel sanctions regimes—each with its own compliance calendar, reporting threshold, and jurisdictional ambiguity. Global Systemically Important Banks (G-SIBs) are absorbing Anti-Money Laundering (AML) and Counter-Terrorist Financing (CTF) operational costs that now routinely run into billions of dollars annually. Fragmentation of cross-border capital clearing paths is the quiet systemic risk few balance sheet models adequately price.

State-Sponsored Cyber Warfare Against Financial Infrastructure

Modern conflict is not confined to physical theaters. Interbank clearing networks, SWIFT infrastructure, retail payment rails, and wholesale settlement systems are high-value targets for state-sponsored cyber actors operating in gray zones adjacent to active conflicts. The proliferation of eight interstate wars dramatically expands the population of state actors with both motive and capability to deploy destructive cyberweapons against Western financial infrastructure. Capital expenditure on operational redundancy is rising sharply across the sector—but it is not rising uniformly, and second-tier institutions represent systemic vulnerabilities that larger players’ spending cannot offset.

Emerging Market Capital Flight and Currency Crises

Widespread and simultaneous conflict catalyzes a structural reallocation of global capital. Institutional investors accelerate exits from emerging market positions toward safe-haven G-SIBs and Western financial centers—a rational response that nonetheless creates self-reinforcing downward spirals. The countries that most need foreign direct investment to stabilize post-conflict recovery are precisely those most likely to face currency depreciation, balance-of-payments crises, and elevated local bank insolvency risks. Pakistan—a nuclear-armed state with active conflicts on multiple fronts—illustrates the extreme end of this dynamic.

The Regulatory and Legislative Imperative

The standard toolkit of bank regulation—stress tests calibrated to historical recession scenarios, capital buffer requirements anchored to peacetime credit cycles, and AML frameworks designed for a world of four or five active interstate conflicts—was not designed for this environment. The UCDP data demands a recalibration.

Specifically, regulators and legislators should consider four areas of urgent focus. First, geopolitical scenario integration in stress testing: the Federal Reserve, the ECB, and national regulators should develop mandatory stress test scenarios that model simultaneous conflicts in multiple systemically important regions, rather than treating geopolitical risk as a tail scenario appended to traditional macroeconomic shocks.

Second, dynamic sanctions compliance infrastructure: the pace and scale of new sanctions designations has outpaced the compliance technology most mid-tier banks deploy. Legislative frameworks that establish shared industry infrastructure for real-time sanctions screening could reduce both compliance costs and systemic exposure.

Third, cyber resilience standards for financial infrastructure: the expansion of state-level conflict actors with financial sector cyber capabilities requires that the SWIFT network, central bank settlement systems, and critical payment infrastructure be treated as national security assets subject to hardened resilience standards—not just commercially motivated upgrades.

Fourth, emerging market contagion protocols: the IMF, World Bank, and regional development banks need pre-positioned facilities—beyond the current Special Drawing Rights and contingent credit line frameworks—that can rapidly provide liquidity support to economies facing conflict-induced currency crises before local banking systems reach insolvency thresholds.

The Cost of Inaction

UCDP senior analyst Shawn Davies noted that for a long time, interstate wars were relatively rare, but recent developments point to growing international tensions and a changing global security order. That understated observation carries enormous implications for anyone responsible for the safety and soundness of the global banking system.

The 153,643 battle-related deaths recorded in the UCDP’s best estimate for 2025—with a high-end projection approaching 237,000—represent an incalculable human tragedy. But embedded in those numbers, spread across 65 active conflicts on six continents, are the preconditions for financial instability that no institution in the current regulatory architecture is fully equipped to manage.

The question for bank regulators, central bankers, and the legislators who write their mandates is not whether this conflict environment will test the global financial system. The data suggests it already is. The question is whether the regulatory response will be calibrated to the world that now exists or the quieter one we thought we had left behind.

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