Geopolitical Risk Slashes Cross-Border Bank Lending by 4 Percentage Points

A new study by Bank of England staff reveals that geopolitical risk significantly impacts bank lending, reducing cross-border credit growth by about 4 percentage points annually for firms facing higher risk. This finding is based on confidential data from British banks and earnings calls from companies, allowing for a business-by-business risk assessment. The discount on cash flow varies by sector, with financial firms and manufacturers experiencing the sharpest declines in lending, while mining and defense sectors saw little to no reduction.

Sanctions emerge as the most severe form of geopolitical risk, triggering the most intense reactions from banks. Lending drops more sharply when companies are exposed to sanctions, either directly or through their supply chains. Banks also adjust lending based on political alignments, favoring borrowers in geographically closer political blocs. This financial separation begins before official sanctions are imposed, affecting even companies on the periphery of the measures.

The global cost of financial fragmentation is substantial. Rising geopolitical risk leads to reduced cross-border borrowing, lower GDP, weaker equity prices, and currency pressure, while inflation tends to rise and monetary policy tightens. The International Monetary Fund estimates that trade fragmentation could cost global output between 0.2% and 7%, with foreign direct investment fragmentation adding another 2% in a two-bloc world scenario.

The study highlights that banks with stronger capital adequacy ratios and liquidity buffers are better equipped to handle geopolitical risks, while weaker banks react more sharply. This underscores the importance of lender composition for companies operating in multiple jurisdictions, as the stability of funding can be as critical as the industry itself during times of crisis.