Geopolitics meets monetary policy: decoding their impact on cross-border bank lending

Summary

Focus

Geopolitical tensions have soared in recent years. Our paper identifies and quantifies the effects of this geopolitical fragmentation and its interaction with monetary policy transmission in cross-border bank lending.

Contribution

We identify the interaction of the effects of geopolitical tensions and monetary policy in cross-border bank lending. We use the BIS's unique data set on international banking to extract granular quarterly data, from Q2 2012 to Q4 2023, broken down by bank nationality, currency and sector. Our identification is based on the premise that monetary policies associated with currencies are independent of geopolitical tensions arising between the home countries of lending banking systems and the borrowers' countries. For example, we examine how the transmission of US monetary policy interacts with the impact of rising geopolitical tensions between the United Kingdom and Russia in shaping US dollar-denominated cross-border bank lending from UK banks to borrowers in Russia.

Findings

We find economically and statistically significant effects. Geopolitical tensions between countries reduce cross-border bank lending between them. Furthermore, there is an interaction between geopolitical tensions and monetary policy: elevated geopolitical tensions amplify the international transmission of monetary policies. Finally, the effects are particularly strong when geopolitical tensions coincide with monetary policy tightening.

Abstract

We use bilateral cross-border bank claims by nationality to assess the effects of geopolitics on cross-border bank flows. We show that a rise in geopolitical tensions between countries - disagreements in UN voting, broad sanctions, or sentiments captured by geopolitical risk indices - significantly dampens cross-border bank lending. Elevated geopolitical tensions also amplify the international transmission of monetary policies of major central banks, especially when geopolitical tensions coincide with monetary policy tightening. Overall, our results suggest that geopolitics is roughly as important as monetary policy in driving cross-border lending.

JEL classification: E52, F34, F42, F51, F53, G21

Keywords: monetary policy, geopolitical tensions, cross-border claims, diff-in-diff estimations