Using hand-collected data spanning more than a decade on European banks’ sovereign debt exposures, we show that cultural stereotypes influence banks’ investment decisions. Trust of the residents of a bank’s country in the residents of a potential investment country has a positive, statistically significant, and economically important association with its cross-border sovereign exposures. In identifying cultural stereotypes at the bank level, we leverage the branch networks of multinational banks. This allows us to compare the sovereign exposures of banks headquartered in the same country, at the same point in time, with regard to the same target country, thus ruling out confounding factors at country and country-pair levels. We find the effect of cultural stereotypes to be persistent over time and to be more prevalent for less diversified banks as well as for countries not commonly held in bank portfolios. This is the first evidence on the importance of trust for bank lending to governments.

zcarol2@ceibs.edu