Interconnectedness of the banking sector as a vulnerability to crises

Abstract

This paper uses macro-network 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, the macro-network also accounts for financial linkages to the other main financial and non-financial sectors within the economy. We find that a more central position of the banking sector in the macro-network significantly increases the probability of a banking crisis. By analyzing the different types of risk exposures, our evidence shows that credit is an important source of vulnerability. Finally, our early-warning models augmented with interconnectedness measures outperform traditional models in terms of out-of-sample predictions.