Emerging risks

What Are Emerging Risks?

Emerging risks are newly identified or evolving threats that have the potential to significantly impact financial markets, institutions, or the broader economy. Unlike traditional, well-understood dangers such as standard credit risk or market risk, emerging risks are often characterized by high uncertainty regarding their likelihood, magnitude, and transmission channels. They represent a critical component of modern risk management within the broader category of financial risk management. Proactive identification and assessment of these risks are crucial for maintaining financial stability and resilience.

History and Origin

The concept of emerging risks has evolved significantly with the increasing complexity and interconnectedness of the global financial system. While the idea of unforeseen dangers has always existed, the formal focus on "emerging risks" as a distinct category gained prominence in the late 20th and early 21st centuries. This shift was partly driven by rapid technological advancements, globalization, and growing awareness of systemic vulnerabilities. Financial crises, such as the 2008 global financial crisis, highlighted how previously unappreciated or underestimated risks could cascade through the system, leading to widespread disruption. Regulatory bodies and international organizations began to emphasize the need for forward-looking risk identification beyond historical data. For instance, the World Economic Forum (WEF) publishes an annual Global Risks Report, which has become a seminal publication in identifying and analyzing emerging global risks. The 2025 edition of this report highlights an increasingly fractured global landscape with escalating geopolitical, environmental, societal, and technological challenges threatening stability.⁴

Key Takeaways

• Emerging risks are novel or evolving threats with uncertain impacts on financial entities or the economy.
• They often stem from shifts in technology, geopolitics, environment, or societal behavior.
• Identification and assessment of emerging risks are crucial for robust portfolio management and financial resilience.
• These risks can become significant drivers of financial instability if not adequately understood and managed.

Interpreting Emerging Risks

Interpreting emerging risks involves understanding their potential nature, scope, and impact, despite limited historical data. It requires a forward-looking perspective, often relying on expert judgment, qualitative analysis, and horizon scanning. Rather than a numerical interpretation, assessing emerging risks focuses on identifying potential scenarios and their implications. For example, recognizing the growing threat of cybersecurity risk involves understanding how cyberattacks could disrupt operations, compromise data, or undermine public trust, rather than assigning a precise probability to each incident. Similarly, evaluating climate risk involves considering both the physical impacts of climate change and the transition risks associated with policy and technological shifts. Effective interpretation helps organizations develop adaptive strategies and allocate resources to mitigate potential future losses.

Hypothetical Example

Consider a hypothetical investment firm, Global Capital Partners, managing diversified portfolios. In late 2024, their risk management team identifies "quantum computing supremacy" as an emerging risk. While still theoretical, the team recognizes that if a powerful quantum computer capable of breaking current encryption standards were developed, it could pose a severe threat to data security, financial transactions, and secure communication systems worldwide.

Step 1: Identify the Risk. The team notes advancements in quantum computing research and the increasing investment in the field.
Step 2: Assess Potential Impact. They consider that such a breakthrough could render current cryptographic protocols obsolete, exposing sensitive client data and financial transactions to breaches. This could lead to massive operational risk and reputational damage.
Step 3: Estimate Likelihood and Timeline. Although the exact timeline is uncertain, experts suggest it could be within the next 10-15 years. The likelihood of a "breakthrough event" within that timeframe is considered low but with potentially catastrophic consequences.
Step 4: Develop Mitigating Strategies. Global Capital Partners begins to investigate quantum-resistant cryptographic solutions and allocates a small budget for research into post-quantum cryptography. They also start discussions with technology providers to understand their preparedness and potential solutions, ensuring they are not caught unprepared by this potential Black Swan event.

Practical Applications

Emerging risks appear across various facets of finance and economics, influencing strategic planning, regulatory oversight, and investment decisions.

• Investment Management: Asset managers integrate the assessment of emerging risks, such as geopolitical risk or unforeseen technological disruptions, into their scenario analysis and portfolio construction. This helps them anticipate and potentially capitalize on future market shifts or prepare for adverse outcomes.
• Banking and Lending: Financial institutions, especially large ones, are increasingly required to consider emerging risks like climate-related financial risks in their lending practices and capital planning. For instance, in October 2023, U.S. federal banking regulatory agencies, including the Federal Reserve Board, jointly finalized principles for managing climate-related financial risks for large financial institutions, covering aspects like governance, strategic planning, and stress testing.³
• Insurance: Insurers are at the forefront of identifying emerging risks, as their business model directly depends on understanding future liabilities. They continuously monitor new threats, from pandemics to evolving environmental hazards, to adjust underwriting models and product offerings.
• Regulatory Oversight: Central banks and financial regulators actively monitor emerging risks to safeguard financial stability. The International Monetary Fund (IMF), in its Global Financial Stability Report, frequently highlights increasing global financial stability risks driven by tighter financial conditions and heightened trade and geopolitical uncertainty, emphasizing new vulnerabilities.² Similarly, the Financial Stability Board (FSB) regularly publishes reports addressing various emerging threats, including the speed of bank runs accelerated by social media and digital banking, which poses new challenges to traditional stability measures.¹

Limitations and Criticisms

While focusing on emerging risks is vital, it comes with inherent limitations. The very nature of these risks—their novelty and uncertainty—makes them challenging to identify and quantify accurately. Critics argue that predicting truly novel risks can be akin to "gazing into a crystal ball," leading to either over-preparation for unlikely events or a failure to foresee truly impactful ones.

One significant challenge is the potential for "unknown unknowns." By definition, these are risks that have not yet manifested or been conceived, making them impossible to prepare for directly. Furthermore, allocating resources to prepare for ill-defined emerging risks can divert attention and capital from managing more immediate and quantifiable threats. There's also the risk of "analysis paralysis," where continuous monitoring of potential future risks delays necessary action on current issues. The interconnectedness of global systems can also lead to rapid contagion, making it difficult to isolate and manage an emerging risk before it becomes systemic. Despite these challenges, ongoing vigilance and adaptable risk frameworks remain essential.

Emerging Risks vs. Systemic Risk

While both "emerging risks" and "systemic risk" pertain to threats to financial stability, they represent different phases or characteristics of potential dangers.

• Emerging Risks: These are risks that are new, evolving, or have an uncertain impact. They are often not fully understood or widely recognized yet. The focus is on early identification and foresight. An emerging risk might be a novel technology, a new geopolitical dynamic, or a previously underestimated environmental factor that could potentially disrupt the system.
• Systemic Risk: This refers to the risk of collapse of an entire financial system or market, as opposed to the collapse of individual entities. It's the risk that the failure of one or a few entities could trigger a cascade of failures throughout the system, leading to a broader economic crisis. Systemic risk implies a high degree of interconnectedness and potential for economic uncertainty.

In essence, an emerging risk is a nascent threat that, if it materializes and propagates through interconnected channels, could become a systemic risk. Not all emerging risks will lead to systemic crises, but all systemic crises were, at some point, either an emerging risk or a combination of underestimated traditional risks.

FAQs

What is the primary difference between an emerging risk and a known risk?

The primary difference lies in predictability and understanding. A known risk has established historical data and clear methodologies for assessment and management. An emerging risk is novel, evolving, or has highly uncertain characteristics, making its potential impact and likelihood difficult to quantify.

Why are emerging risks difficult to manage?

Emerging risks are difficult to manage due to their inherent uncertainties regarding their probability, severity, and propagation channels. They often lack historical data, making traditional quantitative risk models less effective. Managing them requires flexible frameworks, qualitative analysis, and continuous monitoring.

Can a single emerging risk cause a financial crisis?

Yes, a single emerging risk can potentially trigger a financial crisis, especially if it leads to widespread contagion across interconnected financial institutions or markets. The 2008 financial crisis, for instance, stemmed from an emerging risk in subprime mortgages that became systemic.

What are some examples of current emerging risks?

Current examples of emerging risks often cited by financial authorities and global bodies include escalating geopolitical risk, climate change-related physical and transition risks, rapid advancements in artificial intelligence (AI) and its societal or financial implications, and increasing cyber threats.