Europe's largest banks are confronting the prospect of smaller global footprints in the coming years as major military conflicts destabilize international relations and fracture the global financial system.

The Russia-Ukraine war, rising tensions in the Middle East amid Israel's conflict with Hamas and the prospect of a serious deterioration in US-China relations over trade and the status of Taiwan are threatening European banks that have pursued growth in developing markets in recent decades. Some 80 of the 206 countries and territories that S&P Global Intelligence & Analytics assessed had a high to severe overall strategic risk level as of April 10, with 71 of them outside of Europe.

"The idea of global financial integration and the idea that banks over a long-term horizon could become globally integrated businesses has taken a hit," said Nicolas Véron, senior fellow at Belgian think tank Bruegel and Peterson Institute for International Economics. "It's a really difficult strategic dilemma for European and, more generally, Western banks."

Financial services firms have a higher exposure to geopolitical risk than businesses in other sectors due to their leading role in implementing Western government sanctions and lending to multinational firms through corporate and investment banking units, according to Derek Leatherdale, managing director of GRI Strategies and visiting scholar at The London Institute of Banking and Finance. European lenders have already suffered significant losses from the sale or suspension of their Russian businesses, while others face similar hits when scaling back operations in riskier markets.

The recent increase in macroeconomic and geopolitical risks for Europe's banks requires close attention, Claudia Buch, Europe's top banking supervisor, warned in February. Adapting its supervision to the new environment is one of the European Central Bank's priorities, she said.

The heightened uncertainty has forced some of Europe's largest lenders to dampen earnings expectations for the coming quarters. BNP Paribas SA, the eurozone's largest bank, revised down its 2025 targets in February. "The economic outlook in Europe and geopolitical uncertainties have obviously made us cautious," CEO Jean-Laurent Bonnafé said during an earnings call.

The geopolitical environment is "very challenging," Raiffeisen Bank International AG CEO Johann Strobl told shareholders at the Austrian bank's annual general meeting on April 2. Raiffeisen has the largest remaining Russian operations of any European bank.

Risk and reward

Several European banks with significant global footprints have scaled back their international operations since 2022, although none has directly attributed the moves to rising geopolitical tensions.

Société Générale SA, which was forced to sell its Russian business at a loss in the aftermath of the country's full-scale invasion of Ukraine, has since exited several African markets. The bank sold its Moroccan business for €745 million in April, while its presence in Tunisia is under review.

The retreat followed a recent trend of exits from African markets by French rivals BNP Paribas, Crédit Agricole SA and Groupe BPCE, as well as UK-based banks Standard Chartered PLC and Barclays PLC.

"These entities [in geopolitically sensitive markets] may add a couple of basis points to European banks' earnings, but the potential for reputational damage and damage to the share price is so much higher," said Johann Scholtz, bank equity analyst at Morningstar. "That's why European banks are definitely pulling things a bit closer to home."

Research published in January by Leslie Sheng Shen, a senior economist at Federal Reserve Bank of Boston, found that increasing geopolitical risk negatively affected US bank lending. Its findings could be even more applicable to European banks given their greater exposure to regions of higher geopolitical risk, such as Russia, Sheng Shen said in an email.

"The rising geopolitical risk increases the credit risk of banks which have exposure to the affected countries," the report said. "And when banks move to satisfy capital requirements and lower that exposure, reducing domestic lending is often the easiest way to go."

Democratic uncertainty

A record year for elections around the world is compounding uncertainty, as the largest-ever number of people will vote in polls in countries including the US, India, the UK and South Africa before the end of 2024.

A win for former president Donald Trump in November's US presidential election poses risks for the European economy, according to an April 2 report from consultancy Capital Economics. Trump is threatening to introduce a universal tariff of 10% on all imports, which would reduce European business with what is by far the eurozone's largest export market.

The combination of increased global trade frictions and weaker US growth that Trump's policy would create could prompt eurozone GDP to fall by half a percentage point over a year or two, Capital Economics forecasts. European banks would likely see a reduction in loan growth and increased debt financing problems among companies more reliant on exports to the US as a result.

The future of US relations with China is also a concern for European banks. US support for Taiwan, which China claims as part of its territory, could become a flashpoint in relations between the two superpowers. The countries' recent disputes over trade could also intensify soon as Trump is proposing a 60% tariff on imports from China.

Increasingly adversarial US-China relations have been the "more structural driver of geopolitical risk assessment" in recent years, rather than the Russia-Ukraine war, said Véron. "There is a clear sense that the trajectory of China will not be one of convergence with any definition of the global system," he said.

HSBC Holdings PLC and Standard Chartered are the European banks with the most exposure to China, at $170 billion and $63 billion respectively.

"A big question mark will be if and when China takes military action against Taiwan," said Sam Theodore, an independent banking consultant. "China would have massive sanctions imposed on it, so what are the banks going to do because many more European banks with more money are present in China than were ever present in Russia."

Opportunity knocks

Still, rising geopolitical tensions are also presenting opportunities for European banks. Some markets, particularly Vietnam, Thailand, South Korea and Mexico, have benefitted from trade tensions between the US and China, according to Capital Economics.

The "nearshoring boom" of US companies relocating manufacturing facilities and supply chains closer to home has been a particular boost to Mexico, where Spain-based Banco Bilbao Vizcaya Argentaria SA is the largest lender. BBVA is forecasting the trend to drive loan growth and revenues in what is its most profitable market even higher in the coming years.

Many European banks are also continuing to develop their operations in China, with Standard Chartered recently following the likes of UBS Group AG, HSBC and BNP Paribas in launching a fully owned local investment banking unit.

Increasing geopolitical risk can also generate demand for the services of larger, multinational banks among certain clients, said Benjie Creelan-Sandford, European banks equity analyst at Algebris Investments.

"These clients are looking for banks that are able to give them advice about how best to navigate the various challenges presented by current heightened global uncertainties," he said.

'Think the unthinkable'

The recent rise in geopolitical tensions is increasing the risk of global economic and financial fragmentation that would pose a serious threat to financial stability, according to a 2023 report by the International Monetary Fund. Financial fragmentation affects cross-border investment, international payment systems and asset prices, which in turn fuels instability by increasing banks' funding costs, lowering their profitability and reducing their lending to the private sector, the report said.

To protect themselves against further damage from geopolitical risks, more European banks need to "think the unthinkable," undertake scenario planning and bolster their resilience, said Véron.

"I believe most banks are doing that, but probably not all to the extent they should," he said. "Even then, that doesn't really address their strategic dilemmas."