Geopolitical events impact global banking credit asymmetrically

A new Bank for International Settlements working paper reveals that geopolitical events impact international bank credit asymmetrically. Negative events reduce credit significantly more between geopolitical blocs than positive events, a phenomenon linked to the trust-intensive nature of financial transactions.

Negative shocks hit cross-border lending harder

The study, utilizing confidential BIS International Banking Statistics from 1977 to 2024 across 12,000 country pairs, identifies a pronounced asymmetry.

Adverse geopolitical events, such as Russia's invasion of Ukraine in 2022, the annexation of Crimea in 2014, and the Soviet invasion of Afghanistan in 1979, reduce cross-border credit by 10-20 percent more between geopolitical blocs than within them.

In stark contrast, positive geopolitical events, like the fall of the Berlin Wall in 1989, do not generate a comparable expansionary effect on international credit, even when they boost trade flows.

This finding highlights a unique vulnerability of international banking to geopolitical tensions.

Trust: The missing link in financial flows

The authors hypothesize that this asymmetry stems from the higher level of trust required for international bank credit compared to trade in goods.

Financial transactions, especially long-term and unsecured, involve a more pronounced intertemporal dimension, demanding greater commitment over time.

Goods trade, by contrast, often entails immediate exchange for tangible collateral over shorter horizons.

When geopolitical tensions erode trust, or when trust needs to be re-established between distant blocs, rebuilding the confidence necessary for financial transactions proves more challenging and slower than for trade in goods.

This explains why financial flows fail to expand in response to positive geopolitical events that simultaneously boost trade.

A timely, nuanced perspective

This paper provides crucial empirical backing for the burgeoning field of geoeconomics by examining financial fragmentation over a long historical period.

Its unique focus on both positive and negative geopolitical events, coupled with the emphasis on trust, offers a nuanced understanding of international finance.

The findings underscore that banking and trade do not always move in lockstep, revealing the distinct sensitivities of financial flows to geopolitical shifts.