Payment System and Bank Systemic Risk

Abstract

This paper investigates the critical role of payment systems in transmitting system risk in the European banking sector during the last pandemic. Using a dataset of 67 EU banks from 2017 to 2022, we provide novel and affirmative evidence that the payment system is a significant conduit for shock propagation. Our analysis documents that banks exposed to the payment system (hereafter, PSRI banks) are more likely to contribute to systemic risk during the COVID-19 pandemic. We also highlight the underlying mechanism into force: PSRI banks demonstrate greater vulnerability to macroeconomic fluctuations and experience liquidity pressures, particularly when heavily reliant on short-term funding. As a result, investors charge higher risk premiums on these banks due to their increased exposure to economic downturns. However, our study emphasizes that interbank and wholesale markets represent important sources of resilience for PSRI banks. Specifically, PSRI banks with greater reliance on interbank and wholesale funding exhibit comparatively lower systemic risk, thus reducing their exposure to shocks. Overall, our findings suggest that during economic shocks, the interbank and wholesale markets help mitigate disruptions and vulnerabilities within the payment system, maintaining stability and fostering resilience.

Keywords: payment systems, systemic risk, COVID-19