Interconnectedness of the Banking Sector as a Vulnerability to Crises

35 Pages Posted: 15 May 2015

See all articles by Michela Rancan

Michela Rancan

European University Institute

Peter Sarlin

Hanken School of Economics; RiskLab Finland

Tuomas A. Peltonen

European Central Bank (ECB)

Date Written: May 13, 2015

Abstract

This paper uses domestic and cross-border linkages to measure the interconnectedness of the banking sector, and relates it to banking crises in Europe. Beyond cross-border financial linkages of the banking sector, we also account for financial linkages to the other main financial and non-financial sectors within the economy. We enrich conventional early-warning models using macro-financial vulnerabilities, by including measures of banking sector centrality as potential determinants of banking crises. Our results show that a more central position of the banking sector in these so-called macro-networks significantly increases the probability of a banking crisis. By analyzing the different types of risk exposures, our evidence shows that credit as well as market risks are important sources of vulnerabilities. Finally, the results show that early-warning models augmented with interconnectedness measures outperform traditional models in terms of out-of-sample predictions of recent banking crises in Europe.

Keywords: Financial interconnectedness, Macro-networks, Banking crises, Early-warning model

JEL Classification: F36, G20

Suggested Citation

Rancan, Michela and Sarlin, Peter and Peltonen, Tuomas A., Interconnectedness of the Banking Sector as a Vulnerability to Crises (May 13, 2015). Available at SSRN: https://ssrn.com/abstract=2605810 or http://dx.doi.org/10.2139/ssrn.2605810

Michela Rancan

European University Institute ( email )

Villa Schifanoia
133 via Bocaccio
Firenze (Florence), Tuscany 50014
Italy

Peter Sarlin (Contact Author)

Hanken School of Economics

PO Box 479
FI-00101 Helsinki
Finland

RiskLab Finland ( email )

Turku, 20520
Finland

HOME PAGE: http://risklab.fi/people/peter/

Tuomas A. Peltonen

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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