European Central Bank research finds major geopolitical shocks erode bank capital and underscores use of releasable macroprudential buffers

The European Central Bank published a Macroprudential Bulletin article analysing how geopolitical risk relates to bank solvency and what that implies for macroprudential policy. Using 120 years of data, it finds that higher geopolitical risk has historically been associated with lower banking sector capitalisation, with the largest effects concentrated in major geopolitical events rather than more localised shocks. The analysis links capital depletion to multiple channels, including weaker economic activity, higher inflation, increased sovereign risk, and shifts in capital flows and asset prices. Panel estimates for 17 countries over 1900-2020 associate a two standard deviation increase in a country-level geopolitical risk index with around a 0.2 percentage point decline in the bank capital-to-assets ratio on average, and the effect is non-linear, with major events linked to a 0.53 percentage point decline versus 0.07 percentage points for less major events. Capitalisation fell sharply during the two world wars, averaging a 5 percentage point drop, and the impact varied across countries, with France, Germany, Italy and Belgium experiencing around a 1 percentage point contraction during major shocks while effects were smaller or not statistically significant in several others. The article argues that microprudential supervision and macroprudential policy are complementary, with supervision embedding geopolitical risk in capital and liquidity planning and system-wide releasable capital buffers providing capacity to absorb losses while maintaining key financial services when shocks materialise.