Geopolitical Risk and Global Banking

Abstract

Do banks respond differently to geopolitical risk than to other forms of country risk? Using multiple supervisory datasets and newly constructed geopolitical risk indices, we show that U.S. global banks continue to lend to countries with elevated geopolitical risk through their foreign affiliates, even as they reduce cross-border lending to those same markets. This asymmetric adjustment occurs despite rising credit risk and is distinct from banks' responses to other macroeconomic risks. We explain these findings with a simple model of global banking, highlighting the interaction between banks' funding structure and expropriation risk in driving the observed asymmetry. Furthermore, this mechanism generates significant spillovers: global banks reduce C&I lending to domestic firms in response to rising geopolitical risk abroad, with stronger effects when their foreign affiliates are more exposed.