Anatomy of distress in European banks before and during the crisis
Summary (via Voxeu)
How safe are the banks? This column provides new evidence on what determines the likelihood of an EU bank experiencing distress, suggesting that bank risks have converged across EU members, and that a more tightly integrated financial regulation should reflect this. The results also call for a greater role for market discipline.
Introduction (via Voxeu)
The global financial crisis has highlighted the importance of early identification of weak banks. Problems that are identified late typically cost more to solve. In the EU, authorities have agreed to move towards a more centralised prudential system, an important argument being that the banking sectors of EU members have become increasingly interlinked as a result of financial integration.
But given the importance of this topic, there is a surprising lack of rigorous cross-country analysis of determinants of bank distress in the EU. Most of the bank distress studies focus on the US, which had numerous bank failures that provide a rich data set for a “forensic” examination of the determinants of distress (e.g., Wheelock and Wilson, 2000).
Key finding (via Voxeu)
Among other results, we provide empirical evidence suggesting the importance of contagion effects in the EU banking. Furthermore, we show that banks operating in more concentrated banking sectors are more likely to experience bank distress relative to banks operating in less concentrated markets. Lastly, we show that bank hazards increase with a higher share of wholesale funding, in line with recent theoretical models emphasising this channel of financial vulnerability.