Global financial fragmentation under raised geopolitical risk

Recent geopolitical tensions have intensified, disrupting global financial interconnectedness and increasing market fragmentation. This study explores the adverse effects of global financial fragmentation, driven by geopolitical risk, on banking systems and reducing international risk diversification. We use an autoregressive distributed lag (ARDL) model on panel data from 55 emerging markets and advanced economies from 1990 to 2023. Our findings indicate that rising geopolitical tensions exacerbate global financial fragmentation and increase banking vulnerabilities in the short term. However, banks with higher capital ratios and stronger provisions for non-performing loans show greater resilience to these risks. Geopolitical risk and global financial fragmentation significantly reduce international risk diversification in the long term, more severely impacting EMEs than AEs. The policy implications of our findings emphasize the need to enhance financial resilience, improve risk management, and ensure stable FDI flows.