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 macronetwork also accounts for financial linkages to the other main financial and nonfinancial sectors within the economy. We find that a more central position of the banking sector in the macronetwork significantly increases the probability of a banking crisis. By analysing 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.