Shock contagion, asset quality and lending behaviour: The case of war in Eastern Ukraine

Focusing on the current geopolitical conflict in Eastern Ukraine, this paper examines the economic impact of military intervention on the banking sector and the contagion which is triggered by this type of negative shock. Our study reveals that banks which issued more loans within conflict areas during the pre‐conflict period were subsequently left with a higher level of non‐performing loans in the non‐conflict markets following the onset of the dispute. This impact can be seen most clearly in the regional markets which are closer geographically to the conflict zone. There is also evidence of the “flight to headquarters” effect in local lending. While banks tend to reduce their credit supply, it is within the regional markets located farther from head offices where the most significant reduction in lending can be observed. Further examination shows that the degree of lending reduction is lesser for politically connected banks and for larger banks. Finally, the negative economic effects of the conflict are long‐lasting but less profound once the ceasefire agreements are reached.