A century of geopolitical risk and bank capital resilience
This analysis by Alessio Reghezza, Jan Hannes Lang, and Markus Behn of 17 advanced economies over 120 years demonstrates that extreme geopolitical events—particularly major conflicts—drive measurable declines in bank capital adequacy. While heightened geopolitical risk correlates with reduced capital buffers, only risks exceeding country-specific 90th percentile thresholds (e.g., world wars) cause economically significant solvency pressures. Modern banking systems show increased resilience, with post-1980s regulatory reforms mitigating stability risks except during catastrophic conflicts.
Integrated historical dataset
The study synthesizes two landmark datasets: Caldara and Iacoviello’s news-based geopolitical risk index (GPR) and Jordá-Schularick-Taylor’s macroeconomic database. This merged framework tracks bank capitalization, GDP trends, credit growth, and institutional factors annually from 1900–2020 across Australia, Japan, the U.S., and 14 European nations.
Regression framework design
The authors employed panel regression models analyzing how lagged geopolitical risk impacts bank capital ratios, while controlling for economic growth, inflation, interest rates, and regulatory changes. The design incorporates country- and year-specific fixed effects to isolate geopolitical risk impacts from other macroeconomic shocks.
Findings
Threshold-driven capital impacts
The analysis reveals critical non-linearities in risk transmission:
- Extreme geopolitical crises (top 10% risk events): Trigger 0.5 percentage point capital ratio declines—equivalent to 6% of average pre-crisis capitalization levels (8%). These episodes, often coinciding with world wars, impair solvency through asset quality deterioration and profit compression.
- Moderate tensions (50th–90th percentile risks): Cause negligible 0.07 percentage point declines, suggesting localized conflicts rarely threaten systemic stability absent contagion mechanisms.
Historical Resilience Patterns
World wars precipitated 62.5% capital depletion (5 percentage point drop from 8% baseline), but post-1950s systems showed enhanced shock absorption. Capital buffers expanded from 6.3% (1980s) to 10.4% post-2010, reflecting Basel Accord implementations and improved risk management practices. The weakened post-1950s correlation between geopolitical risk and capital ratios suggests regulatory reforms successfully decoupled routine tensions from solvency concerns.
Policy implications
The findings advocate integrating geopolitical risk scenarios into macroprudential stress tests, particularly for tail events exceeding historical 90th percentiles. Capital conservation buffers—designed for release during crises—emerge as optimal tools for maintaining credit flow during geopolitical shocks. However, the muted impact of moderate risks implies no need for preemptive capital hikes during routine diplomatic tensions, avoiding unnecessary credit constraints.
120 Years of Insight: Geopolitical Risk and Bank Solvency
Authors: Alessio Reghezza, Jan Hannes Lang, Markus Behn
From: European Central Bank
Geopolitical risk and its implications for macroprudential policy
By: Markus Behn, Jan Hannes Lang, Alessio Reghezza – ECB
The impact of geopolitical tensions on European bank funding and equity markets
This paper by Aristeidis Dadoukis, Giulia Fusi, and Athanasios Sakkas presents an empirical investigation into how geopolitical tensions, specifically the Russia-Ukraine war, affected European banks through measurable risk premia in both debt and equity markets. Their methodology includes:
- Data sources:
– Bank fundamentals from the European Banking Authority (122 institutions).
– Debt market data from Dealogic (59 banks), equity data from Refinitiv (49 banks), and CDS prices from S&P Capital IQ.
– Direct exposures to Russia hand-collected from Pillar III disclosures, press releases, and ad-hoc reports.
- Three transmission channels:
– Direct: Credit exposures to Russia as a % of CET1 capital.
– Branch: Operational presence in Russia/Ukraine (% of total branches).
– Real economy: Lending to energy-intensive sectors (77% of EU energy use).
- Econometric models:
– Debt: Panel regressions linking bond spreads to exposures, controlling for fundamentals and instrument features.
– Equity: Event studies (Q1 2022) measuring abnormal returns, volatility, and CDS spreads.
Findings
Debt market risk premia
- Banks with higher direct credit exposures to Russia experienced substantially higher funding costs following the war’s outbreak. A one standard deviation increase in credit exposure was associated with a 36.7% increase in bond spreads relative to the pre-war period. This effect persisted throughout both 6-month and 12-month post-war windows, demonstrating the durability of market concerns.
- The branch channel proved equally significant, with banks having greater operational presence in conflict areas facing elevated borrowing costs. A one standard deviation increase in branch exposure corresponded to a 65.7% increase in spreads. The real economy channel showed more moderate but still significant effects, with energy-intensive corporate exposures leading to a 9.7% increase in spreads.
Equity market responses
- Equity markets demonstrated similar patterns of differential pricing based on exposure channels. Banks with higher direct exposures to Russia experienced lower abnormal returns, increased stock price volatility, and higher CDS spreads throughout the first quarter of 2022. The branch channel showed comparable effects, with operationally exposed banks suffering more severe stock price corrections and elevated default risk pricing.
- The real economy channel provided mixed evidence in equity markets. While funding cost heterogeneity was not consistently explained by energy-intensive corporate exposures, equity investors clearly penalized banks with higher exposures to energy-vulnerable sectors. This suggests that while debt markets focused primarily on direct exposures, equity markets incorporated broader economic spillover concerns.
Role of bank capital
The research found that stronger capital positions helped mitigate adverse spillovers from geopolitical shocks, particularly for the real economy channel during the initial crisis period. However, this protective effect varied across time horizons and exposure types, suggesting that capital’s role as a buffer depends on the specific nature and duration of geopolitical tensions.
Geopolitical risk premia in the European banking sector
Authors: Aristeidis Dadoukis, Giulia Fusi, Athanasios Sakkas
From: University of Nottingham, European Stability Mechanism, Athens University of Economics and Business
