The Return of Political Risk: Foreign-Owned Banks in Emerging Europe

Political risk—risk that investments are damaged by policy action of authorities—increased during the financial crisis due to controversies about the distribution of accumulated losses among stakeholders. Authorities interconnected by cross-border banks considered unilateral policies that minimised losses for domestic stakeholders at the expense of their foreign counterparts. This is at odds both with the assumption behind financial integration which presumes multilateral responses to cross-border shocks and with the typical definition of political risks that ignores the fact that not only host-country, but also home-country authorities can create such risks. This paper recasts the definition of political risk and reviews instances when political risk materialised within the EU banking market between 2007 and 2011. The analysis reveals that the EU regulatory framework needs to be enhanced to contain resurgent political risks systematically rather than through ad hoc interventions of the EU and international bodies.