ECB warns banks of liquidity risk from geopolitical shocks

FRANKFURT (Reuters) - Euro zone banks are resilient but need to be ready for geopolitical shocks and their consequences, including the risk liquidity could dry up amid jittery financial markets, European Central Bank supervisory chief Claudia Buch said on Thursday.

Policy reversals in some key areas by U.S. President Donald Trump's administration have unsettled investors in recent months, and policymakers are now assessing how this could affect growth, stability and financial risk.

This comes on top of financial and political stress created by Russia's war in Ukraine and the Western sanctions that followed.

"A potential deterioration in asset quality and possible economic disruptions caused by geopolitical conflicts or the effects of financial sanctions require heightened attention, sufficient capital and robust governance and risk management systems in banks," Buch said in the ECB's annual report on banking supervision.

Reuters reportedlast week some central bankers and supervisors were even questioning whether they can still rely on the U.S. Federal Reserve to provide dollar funding in times of market stress given Trump's erratic trade and foreign policy.

Asked about this risk during a parliamentary hearing on Thursday, Buch said ECB supervisors continued to work well with their Federal Reserve colleagues but they monitored liquidity "very closely".

"Liquidity risk and also foreign exchange risk is something we monitor very closely as a routine part of our supervisory assessment," she said.

Sources told Reuters they considered it highly unlikely the Fed would not honour its funding commitments and the U.S. central bank itself has given no signals to suggest that.

In its annual report, the ECB spelled out how geopolitical shocks could affect banks.

Among risks ranging from politically motivated cyber attacks to asset seizures, the ECB said banks could face stress relating to liquidity and funding, including in foreign currencies.

This might results in higher borrowing costs, increased use of credit lines and even margin calls, whereby a bank must post more collateral at a clearing house to avoid having its positions liquidated and being shut out of financial markets.

A constant threat during the 2008 global financial crisis, margin calls have all but disappeared from the public discourse since then in part thanks to liquidity backstops implemented by central banks such as the Fed and the ECB.

"Geopolitical risks need to be considered within the context of liquidity and capital planning," the ECB's report said.

Buch also said banks also needed to be prepared for cybersecurity threats as both the incidence and the severity of such attacks had increased.

Buch also called on European Union lawmakers to make progress in approving a crisis management and deposit insurance framework to better deal with bank failures and protect depositors.

(Reporting by Balazs Koranyi and Francesco Canepa; Editing by Jan Harvey and Tomasz Janowski)