By Shashank Pattekar, International Banker
Geopolitical tensions, sanctions regimes and regulatory fragmentation are exerting a direct influence on how banks structure their international operations and define risk. Cross-border banking is increasingly becoming an exercise in managing geopolitical exposure as much as in generating sufficient financial returns. As such, markets that were once viewed through a purely financial lens are now evaluated in terms of their geopolitical alignment and regulatory stability.
A February 2025 joint report from the Federal Reserve System (the Fed) and the Bank for International Settlements (BIS) highlights these shifting sands. The research focused on three measures of geopolitical tensions and risks to assess the size of the impacts they have on cross-border bank lending, as well as whether they strengthen or weaken the impacts of the monetary policies of major central banks on cross-border bank lending:
- United Nations voting disagreements between country pairs as a measure of materialised geopolitical tensions;
- Trade, financial, military and other bilateral sanctions, which serve as another measure of materialised geopolitical tensions;
- A potential precursor to geopolitical fragmentation and broad sanctions: geopolitical risk in lender and borrower countries.
“We find that geopolitics affects cross-border bank flows in an economically and statistically significant way,” the study concluded. “The rise in geopolitical tensions directly dampens cross-border bank lending and also amplifies the international transmission of monetary policy.”
The overarching change being implemented by the banking sector is a shift from global integration to managed exposure.
The overarching change being implemented by the banking sector is a shift from global integration to managed exposure. While in the previous phase of globalisation, banks expanded internationally amid a broad operating environment of interconnected markets and aligned regulatory frameworks, in today’s environment of heightened global uncertainty, they are increasingly re-designing their international strategies while acknowledging that fragmentation will persist.
In practice, this means lenders are increasingly concentrating their activities in markets with clear regulations. They are also reducing their exposures to those jurisdictions with higher geopolitical risks and building greater flexibility into their operating models to manage this growing source of potential instability effectively.
Why is this the case? Several reasons, but chief among them is the sheer significance of geopolitical tensions on the global risk landscape. “The multilateral system is under pressure,” explained the World Economic Forum’s (WEF’s) “Global Risks Report 2026”. The report includes a Global Risks Perception Survey, which cites “geoeconomic confrontation” as the risk most likely to pose a material crisis on a global scale in 2026, according to 18 percent of more than 1,300 global leaders and experts surveyed across academia, business, government, international organisations and civil society. This specific risk also increased by two positions from the 2025 survey, claiming the top spot this year.
In the survey, geoeconomic confrontation is followed by another form of geopolitical risk—”state-based armed conflict”—which was selected by a further 14 percent of respondents. As such, the two risks that experts most expect to create a material global crisis this year are both geopolitical. “Declining trust, diminishing transparency and respect for the rule of law, along with heightened protectionism, are threatening longstanding international relations, trade and investment and increasing the propensity for conflict,” the report also noted.
Such a pronounced shift appears to have initially emerged with prominence following the outbreak of conflict in Ukraine in February 2022 and the resulting escalation of sanctions, with banks noticeably reducing their exposures in certain markets while consolidating activity in others. Indeed, the expansion of sanctions regimes, particularly those led by the United States, the European Commission and their allies, has increased the cost and complexity of operating in certain jurisdictions, with banks increasingly required to navigate rules governing transactions, counterparties and financial flows.
Sanctions only represent one piece of the puzzle, however. “A one standard deviation increase in geopolitical risk causes cross-border bank lending to decline by around 4 percent after one year,” the Bank of England’s (BoE’s) December 2025 working paper concluded. Crucially, moreover, the report also noted that this adjustment did not depend solely on formal sanctions or policy restrictions and that banks were also responding to perceived risk, scaling back activity in jurisdictions where political uncertainty was rising before regulatory action was taken.
This is evident in an increasing number of real-world examples. Citigroup has exited the consumer-banking space in multiple markets across Asia and Europe, focusing instead on institutional clients and core geographies. HSBC, meanwhile, has continued to concentrate its strategy on Asia while scaling back in other regions, reallocating capital towards markets it considers strategically aligned. And Standard Chartered has maintained its international footprint, but with greater emphasis on capital efficiency and risk discipline. Such trends underscore the new reality that, amid a decidedly uncertain geopolitical outlook, banks are increasingly willing to make major decisions to reshape their international footprints as they strive to optimise for resilience alongside—or, in some cases, instead of—profitability.
Nonetheless, regulatory regimes continue to play pivotal roles in guiding banks amid growing uncertainty, not least by formally assessing how geopolitical risks and shocks affect the businesses, operations and risk profiles of lenders under their supervision. According to the European Central Bank’s (ECB) Single Supervisory Mechanism (SSM) Supervisory Priorities for 2025-27, for instance, “severe geopolitical shocks” are considered the highest priority, along with macro-financial threats, for supervisory coverage over European banks’ resilience.
“Events such as Russia’s invasion of Ukraine, the Israel–Palestine conflict, United States–China trade frictions and broader shifts in global power balances are reshaping the global landscape and introducing new risks for European banks and supervisors,” according to a November 2025 analysis from the Economic Governance and EMU Scrutiny Unit (EGOV), which provides research to the European Parliament. “While the Banking Union was designed to deal with more traditional risks such as credit, market and operational risk, geopolitical shocks are harder to anticipate ex ante and, once they materialise, propagate through multiple channels with the potential for systemic amplification.”
Such guidance is critical for banks, particularly at a time when geopolitical tensions are driving greater divergence in regulatory frameworks across jurisdictions and a stronger emphasis on financial “strategic autonomy”. In the European Union (EU), governments are increasingly prioritising control over critical financial infrastructure, data flows and capital markets, even at the expense of cross-border integration. For banks, operating internationally increasingly requires navigating a more fragmented regulatory landscape, in which rules are not only different across jurisdictions but also shaped by geopolitical considerations.
Lenders are having to confront more operational friction and a growing incentive to concentrate activity within fewer, more predictable markets. This in itself may lead to a more uneven distribution of financial resources, with markets perceived as stable and aligned with major financial centres likely to attract more investment, while others face reduced access to capital. This asymmetry helps to explain why retrenchment tends to occur first and most aggressively in more vulnerable markets, even when global banks maintain exposure to larger or more systemically important economies.
The empirical evidence appears to support this trend as well. Using data from 44 economies spanning the third quarter (Q3) of 2013 to the fourth quarter (Q4) of 2023, an April 2026 paper examined the impact of country-specific geopolitical risks (CS_GPR) on cross-border bank capital allocation from the perspective of cross-border bank claims and liabilities. “Specifically, this paper demonstrates that CS_GPR drive both domestic and foreign bank capital out of the home banking system,” the research, produced by Capital University of Economics and Business (CUEB) in China, found. “Second, the impact of CS_GPR on bank capital is primarily concentrated in economies with lower levels of economic development and lower capital account openness, highlighting that a developed financial market may mitigate the effects of CS_GPR on bank capital allocation.”
Some research additionally highlights the role of internal capital markets within global banks. Rather than adjusting exposure solely through external lending decisions, multinational banks actively reallocate liquidity across their own networks, shifting funding between headquarters and foreign affiliates in response to changing risk conditions. When perceived risk rises in a particular jurisdiction, parent institutions often reduce funding to local subsidiaries or repatriate capital, tightening credit conditions even in the absence of a formal market exit. This internal rebalancing mechanism means that geopolitical shocks can propagate quickly through the banking system, amplifying the speed and scale of capital retrenchment across borders.