A recent global study has found that election results can significantly impact the stability of a country's banking system. The study, which analyzed 147 national elections across 22 OECD economies between 2000 and 2023, revealed that systemic risk follows a broadly hump-shaped trajectory, dipping before scheduled elections, then rising during and after the vote. This risk remains elevated for up to 12 months, particularly when the incumbent government loses office.
The study, conducted by George Kladakis and Alexandros Skouralis, found that political continuity can be a financial asset for national banking systems. However, the recent experience in Brazil, where Luiz Inácio Lula da Silva narrowly won a presidential runoff vote, shows that continuity does not automatically reassure investors. Lula's surprise victory led to a significant market reaction, with Brazil's benchmark stock index falling 13.9% and its currency losing 8.1% against the US dollar on October 26, the day after the runoff vote.
In contrast, Israel's recent inconclusive election result has left uncertainty over the formation of the next government, leading to increased systemic risk. The country's stock market fell around 3% on October 28, while its currency, the shekel, weakened by approximately 2% against the US dollar. The ten-year government bond yield also rose nearly five basis points to 4.13%, signalling higher borrowing costs. This outcome highlights the challenges Israel faces in establishing durable governing coalitions.
The study also found that snap elections are associated with larger increases in systemic risk. Israel experienced ten elections between 2000 and 2023, seven of which were snap elections. This included five snap elections during its 2018-22 political crisis. The frequency of snap elections in Israel has contributed to the country's financial instability.
Strong economic growth and high public trust in government can cushion the financial blow of elections, as they naturally insulate the banking system. Macroprudential policies, the regulatory guardrails designed to protect the entire banking system, also play a crucial role. By strengthening financial safeguards such as capital buffers for banks, regulators can help the system absorb political shocks.
However, evidence suggests that political incentives to stimulate lending before an election can encourage the loosening of these safeguards. This leaves national financial systems more exposed to subsequent shocks. In Turkey and India, for example, governments have historically used state-owned banks to expand consumer and mortgage credit aggressively before tightly contested elections.
As Brazil and Israel navigate their post-election landscapes, the importance of credible fiscal plans and viable governments cannot be overstated. In Brazil, Lula will need to rebuild market confidence with a credible fiscal plan that explains how campaign promises will be funded and puts public debt on a sustainable path. In Israel, prospects for a viable government remain uncertain, and even if one emerges, it may offer markets only limited reassurance while the war in the Middle East continues to pose risks to financial stability in Israel and worldwide.
Key points
- A recent global study found that election outcomes can have a lasting impact on the stability of a country's financial system.
- Political continuity can be a financial asset for national banking systems, but does not automatically reassure investors.
- Snap elections are associated with larger increases in systemic risk, as seen in Israel's experience with multiple snap elections between 2000 and 2023.
