Global banking and the spillovers from political shocks at the core of the world economy

Abstract

When do political shocks in core countries reverberate across the global financial system? We identify cross-border banking as a distinct transmission mechanism for political shocks. Democratic processes that advance (undermine) the interests of the global banking industry in core economies benefit (hurt) countries with closer banking ties to these economies. Empirically, we leverage the unanticipated outcomes of the 2016 US presidential election and the Brexit referendum to identify the role of cross-border banking in transmitting these shocks. We show that US global banks benefited disproportionately from the US election surprise. Accordingly, countries with closer ties to US banks fared relatively better; exposure to US bank flows cushioned the negative effect of the election. Evidence from Brexit reinforces the banking-channel hypothesis. The findings further our understanding of the role of global banks in the international financial order and underscore the need for more research on the political economy of global banking.