The hidden transmission from war to bank balance sheets

Geopolitical Crisis and the Coming Banking Stress

Geopolitical risk is rarely treated as a balance sheet variable. It sits in risk disclosures, discussed in narratives but excluded from models. Yet history shows that geopolitical shocks transmit into banking systems through clear, repeatable financial channels. This article maps that transmission across multiple crises and builds a framework for analysing its impact in the current environment.

The specific crises change. The underlying logic does not:

Geopolitical disruption → commodity shock → inflation → monetary tightening → asset-liability mismatch → NIM compression → bank stress.

What appears as a sudden banking problem is, in reality, the final stage of a much longer chain of events. By the time stress becomes visible on bank balance sheets, the underlying drivers - supply shocks, price spikes, and policy responses have already been in motion for months.

This sequence is not theoretical. Understanding this transmission is critical. Because banks rarely fail at the point where risk originates - they fail where multiple pressures converge.

How Geopolitics Enters the Banking System

A. Foreign Borrowing

India’s external debt stands at approximately $736 billion, with corporates continuing to access dollar funding. However, the risk profile of these exposures is deteriorating rapidly. Borrowers with unhedged or partially hedged foreign currency liabilities are now facing three concurrent pressures. First, rupee depreciation from ~₹83 to ₹92–95 per dollar has significantly increased the effective repayment burden in local currency terms, without a corresponding improvement in underlying cash flows. Second, the combination of elevated energy prices and a slowing domestic economy is compressing operating performance, weakening debt servicing capacity. Third, hedging costs have risen materially, eroding already strained cash flows and reducing the viability of risk mitigation strategies. The ₹60,000 crore of identified stressed exposure likely represents only the visible portion of the risk. Let’s dive further.

B. Working capital: the self-liquidating loan that stops liquidating

A working capital loan is not a loan in the conventional sense , it is a bet on a cycle completing. The bank extends credit today on the assumption that goods will arrive, be processed, be sold, and generate receivables that repay the line within 60 to 90 days.

The cargo is the collateral, the sale is the repayment, and the entire structure stands only as long as the supply chain keeps moving.

When the Strait of Hormuz closes, that cycle breaks at the very first link: the cargo does not move. A fertiliser manufacturer who drew down its working capital line to pay for an ammonia shipment from the Gulf now has an open debit on its bank account, no goods in its warehouse, no production running, no invoices raised, and no receivables coming in , the 90-day self-liquidating credit has become a frozen, unsecured obligation with no exit mechanism in sight.

Across the entire system, what were structured as short-term, self-liquidating, asset-backed credit facilities have silently converted into medium-term, unsecured, non-performing exposures not because the borrowers are operationally insolvent, not because their businesses have failed, but purely because the physical supply chain that was the repayment mechanism has been severed by the war.

C. Bank Guarantees

Bank guarantees usually sit quietly in the background and don’t look risky because they’re “off the balance sheet.” But in a crisis, they can turn into real losses very quickly. For example, if a contractor can’t complete a project because it’s in a sanctioned country, or an exporter can’t ship goods due to restrictions, or a trader can’t meet margin calls because assets are frozen, the bank guarantee gets triggered. The bank has to pay immediately. What was earlier just a backup promise suddenly becomes an actual cash outflow. And since the client is already under stress, the bank may not recover the money, so this turns into a bad loan.

Now let’s look into the indirect channel..Problem of Duration mismatch

Step 1: Supply disruption
A geopolitical shock- war, sanctions, or disruption of key transit routes restricts the supply of critical commodities such as oil, gas, and food. Unlike prior cycles, supply is not easily substitutable, with chokepoints and fragmented trade routes limiting adjustment. Demand remains inelastic in the near term, forcing a sharp and sustained repricing of inputs.

Step 2: Inflation spreads through the system with weaker growth
Higher commodity prices feed rapidly into the cost structure of the economy. However, unlike demand-driven cycles, this inflation emerges alongside slowing growth. Corporates face rising input costs without commensurate pricing power, compressing margins and weakening cash flows even as inflation broadens across sectors.

Step 3: Central banks raise interest rates
Central banks tighten policy to anchor inflation expectations, despite the supply-driven nature of the shock. This creates a policy trade-off: rates rise not because growth is strong, but because inflation is politically and economically intolerable. The result is tightening into an already weakening economic backdrop.

Step 4: Banks get squeezed
Banks borrow short-term (through deposits) and lend long-term (through loans). When interest rates rise:

• Deposit costs increase quickly, as banks must offer higher rates to retain money.

• Loan income does not adjust as fast, because many loans are fixed or reset slowly.

As a result, the gap between what banks earn and what they pay narrows sharply.

Step 5: Stress builds in the system
If this continues:

• Bank profitability declines

• Losses can emerge if funding costs exceed loan yields

• Some banks may be forced to sell assets at a loss to meet withdrawals

If confidence weakens, depositors may start pulling money out, and stress can escalate into a broader banking problem.

S&L Crisis 1980s

The Savings and Loan crisis remains the clearest example of how a structural asset-liability mismatch not poor credit underwriting or excessive risk-taking can destabilise an entire financial sector. Thrifts were designed to perform a single function: mobilise household deposits and extend long-term, fixed-rate mortgages. This model, shaped by regulation, was stable for decades in a low and predictable interest rate environment.

The vulnerability, however, was embedded in the structure. Liabilities repriced frequently or could be withdrawn on demand, while assets were locked into fixed returns for 20–30 years. As long as rates remained stable, the mismatch was manageable. When rates rose sharply, it became untenable.

The inflection point was driven by geopolitical shocks. The 1973 oil embargo and the 1979 Iranian Revolution pushed US inflation to 14.8% by 1980. In response, Paul Volcker aggressively tightened monetary policy, taking the federal funds rate to 20% by mid-1981.

The impact on thrifts was immediate. Funding costs rose in line with market rates as depositors demanded higher returns, while asset yields remained fixed. This led to a structural inversion - institutions were consistently paying more on liabilities than they were earning on assets, eroding capital on a daily basis.

By the early 1980s, a large portion of the sector was economically insolvent when assessed on a market value basis. However, instead of forcing immediate resolution, regulators opted for forbearance, allowing these institutions to continue operating in the expectation that rate conditions would normalise.

This delayed response amplified systemic risk. Insolvent entities, incentivised to recover losses, increasingly allocated capital to higher-risk segments such as commercial real estate, junk bonds and speculative lending. Losses compounded, and what could have been a contained adjustment evolved into a prolonged crisis.

Between 1986 and 1995, over 1,000 institutions failed.

2022–2023 US regional banking crisis

The 2022–2023 US regional banking crisis was not a new crisis. It was an old one wearing new clothes — the same structural failure that destroyed thousands of savings and loan institutions in the 1980s, replayed with different actors and a faster timeline.

The setup began during 2020–2021, when near-zero interest rates flooded the banking system with cheap deposits. Banks did what banks are supposed to do: they put the money to work. They bought long-duration government bonds and mortgage-backed securities -the most creditworthy assets available. No defaults, no dodgy borrowers, no exotic instruments. Just US government paper.

The problem was not what they bought. It was how long they bought it for.

These bonds locked in yields of 1.5%, 2%, sometimes less, for ten, fifteen, twenty years. That looks reasonable when the world expects rates to stay low indefinitely. It looks catastrophic when the Federal Reserve raises rates by 525 basis points in sixteen months. Because when new bonds are yielding 4.5%, nobody will pay face value for an old bond paying 1.5%. Prices fall — sharply, mechanically, inevitably.

By late 2022, the losses were everywhere, sitting quietly on bank balance sheets across the country. The FDIC estimated that US banks collectively held over $600 billion in unrealised losses on their securities portfolios. But unrealised means exactly that: as long as you hold the bond to maturity, the loss never materialises. The books look fine. The bank looks solvent.

SVB looked fine too , right up until it didn’t.

What made SVB different was its depositor base. Its customers were technology startups, venture-backed companies burning through cash to fund operations. When the VC funding environment tightened in 2022 and 2023, these companies stopped receiving new capital and started drawing down their balances to survive. This was not random noise. It was a coordinated, simultaneous withdrawal from a highly concentrated, deeply correlated depositor base and nearly 90% of those deposits sat above the FDIC’s $250,000 insurance limit, meaning depositors had every rational incentive to move first and ask questions later.

To meet the withdrawals, SVB had no choice but to sell its underwater bonds — turning paper losses into real ones. When it disclosed a $1.8 billion realised loss on those sales, the reaction was instantaneous. Venture capital firms advised their portfolio companies to withdraw via group chats and direct calls. Social media carried the panic further and faster. The bank run that followed was over in roughly 48 hours. One of the largest bank failures in American history unfolded at a speed the system had never seen before.

The lesson is not complicated, but it is easy to forget in a long period of stability.

Oil Shock is hitting the lead banker of India layer by layer : SBI

SBI(State Bank of India) is not a bystander to this crisis. It is the single most concentrated point of energy sector credit risk in the Indian banking system, sitting at the centre of every major exposure category simultaneously.

Project finance frozen mid-construction. In January 2025, SBI led a consortium of six banks signing a ₹31,802 crore loan for BPCL’s Bina Refinery expansion, with a four-year completion target. That clock started ticking just as the Hormuz crisis erupted. Project finance loans are built on projected cash flows from a completed asset - they assume crude supply at budgeted prices, feedstock accessible, product markets functioning, and construction on schedule. The Hormuz closure has attacked every one of these assumptions simultaneously. The loan is not yet an NPA - BPCL is sovereign-backed and will not technically default. But the credit quality has materially deteriorated, and cost overruns requiring additional bank support are now a real probability.

Working capital stretched beyond design limits : Working capital exposures are being stretched beyond their original design parameters. As the lead working capital lender to IOCL, BPCL, and HPCL, SBI is directly exposed to the mechanical impact of rising crude prices and currency depreciation. With crude moving from $60–70 per barrel to peaks of $115, and the rupee weakening concurrently, the funding requirement for the same volume of crude imports has expanded significantly. This increase does not arise from incremental credit decisions but from the automatic drawdown of committed working capital lines. At the same time, LPG under-recoveries have reached ₹53,700 crore, against government compensation of only ₹30,000 crore, leaving a ₹23,700 crore gap on OMC balance sheets financed through bank credit. In effect, SBI is bridging a portion of the fiscal subsidy through its balance sheet, with repayment dependent on government reimbursements that are neither timely nor fully predictable, thereby increasing both exposure and uncertainty within the system.

OMC earnings have collapsed. UBS downgraded BPCL and IOCL to Neutral and HPCL to Sell, citing massive marketing losses. Emkay Global calculates that for every month crude stays at $100 per barrel, OMC profit after tax falls 9%, inflation rises 50 basis points, and the current account deficit widens by 9–10 basis points of GDP. SBI’s largest borrowers are generating losses, not cash flows making the bank increasingly reliant on government intervention as the de facto repayment mechanism.

NIM and treasury losses compound everything. As oil-driven inflation pushes bond yields higher, SBI’s government securities portfolio — the largest of any Indian bank — faces mark-to-market losses. Credit demand is slowing, funding costs are sticky, and asset quality is weakening. All four variables are moving in the wrong direction at the same time.

The recent trading disruption involving State Bank of India highlights a deeper shift in India’s currency market dynamics, where regulatory intent is beginning to override pure market forces. Following a clampdown by the Reserve Bank of India on offshore rupee derivative trades, SBI was forced to unwind nearly $5 billion worth of short positions on the rupee, resulting in an estimated loss of around ₹300 crore. While financially manageable for a bank of SBI’s scale, the episode underscores a larger message: the RBI is willing to sacrifice market liquidity and disrupt positioning to defend currency stability.

Geopolitical risk does not announce itself on a bank's balance sheet. It arrives quietly, disguised as a commodity price, a currency move, a working capital drawdown, or a yield shift and by the time it becomes visible as credit stress or a liquidity event, the chain of causation stretches back months, sometimes years.