The codependence between Banking and sovereign Risk Europe and the Potential Benefits of a Banking Union

Purpose and goal

The revised proposed project will shed light on the causes of systemic bank contagion risk between bank in the Euro-zone and its consequences on the sovereign stability across European countries. This study aims at informing the policy debate on how to monitor and reduce bank contagion risk by offering novel evidence on the determinants of this risk in European banking and by assessing its implications on sovereign stability.

Results and expected effects

We have already conducted a first draft on part 1 of the revised project. But we will include the ownership interlocking variables also as a counterparty risk in the upcoming draft. We find the evidence of contagion in bank CDS during global and Eurozone crises. The empirical results demonstrate that the similarity in banking business positively influence excess correlation and the relationship amplify when the banks operate domestically. We also find that systemic size and use of derivatives help intensify the relationship even further.

Approach and implementation

In this study, we adopt a novel empirical approach to offer evidence on the importance of different channels of transmission of shocks to bank CDS contagion in a sample of 54 European Banks over the period of 2004-2013. In particular, we focus on the role played by bank interdependence and, more broadly bank similarities. We use income similarity as a measure of banks interdependence.