2024-01-12 12:00:07
Lhe increased risk following geopolitical events abroad, such as the Russian invasion of Ukraine, the escalation of tensions between China and Taiwan or the conflict in the Middle East, have a systematic and negative impact on the lending conditions of American banks on the American market. It may seem paradoxical that a geopolitical risk abroad thus affects the domestic market. The mechanism is as follows: the increase in geopolitical risk increases the credit risk of banks exposed to the countries concerned. And when these banks take steps to comply with capital requirements and reduce this exposure, restricting domestic lending is often the easiest method, while, surprisingly, they continue to lend to countries where capital geopolitical risk increases.
The study “Geopolitical Risk and Global Banking” (Friederike Niepmann and Leslie Sheng Shen, unpublished), presented on Saturday December 9 at the CEPR Paris Symposium, particularly documented a clear increase in the average probability of default on loans granted to Russian and Ukrainian borrowers, after Russia’s annexation of Crimea in late 2013 and the invasion of Ukraine in early 2022. This effect is also evident across a range of geopolitical events and has a significant impact on the aggregate credit risk of exposed banks.
Capital requirements limit the risks that banks are allowed to take, and banks must respond to increases in credit risk by reducing their portfolio exposure. They might be expected to reduce their exposure to countries where geopolitical risk is increasing. However, we see on the contrary that the exposed banks are largely continuing their external loans.
Loans that increase
These external loans come in two forms: banks can lend locally through their branches or subsidiaries abroad, or they lend cross-border, through their establishments in their country of origin. Our analysis shows that while banks tend to reduce their lending from establishments located outside countries where geopolitical risk increases, their lending through local headquarters in these same countries continues or even increases. For what ?
Certain aspects of the events following the Russian invasion of Ukraine in February 2022 may help explain this paradox. At the time of the invasion, several major global banks, including the Italian UniCredit, the French Société Générale (SG), the American Citigroup and the Austrian Raiffeisen Bank International (RBI) were heavily exposed in Russia. SG sold (at a loss) its Russian subsidiary shortly after the invasion, but other global banks are withdrawing much more slowly. UniCredit, Citigroup and RBI still own their Russian subsidiaries.
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