Staff Working Paper No. 1,164
By Dennis Reinhardt, Julian Reynolds and Rhiannon Sowerbutts
How does geopolitical risk affect cross-border bank lending? To examine this question, we exploit a rich cross-border bank lending data set from the UK which records banks' large exposures to individual firms and match this with a firm-level measure of geopolitical risk, derived from firms' earnings call reports. Combining granular firm-level data points with tight fixed effect specifications, we find that a one standard deviation increase in geopolitical risk causes cross-border bank lending to decline by around 4% after one year. This effect is not uniform: lending to financial sector firms declines most, while energy and defence sectors show no significant impact; also better-capitalised banks are less sensitive to borrower risk. Effects vary with geopolitical alignment between bank and firm nationalities and are more significant for sanctions-related risk. Finally, local projections show that geopolitical risk transmits to cross-border lending via macroeconomic aggregates and asset prices, with transmission influenced by credit growth dynamics and sanctions as the primary risk driver.
Geopolitical risk and cross-border bank lending