Unravelling Systemic Risk Determinants in the European Banking Sector: <i>Is it Just a Matter of Size?</i>

What the paper says

Given the well-established role of banking sector instability in driving financial and economic crises, this paper investigates the potential determinants of systemic risk on a selected sample of European listed banks. Drawing from a comprehensive review of literature, we employ a novel LASSO (Least Absolute Shrinkage and Selection Operator) enhancement of a panel data regression model to pinpoint the balance-sheet factors that significantly explain the systemic risk levels of the banking institutions. The analysis highlights that the interbank exposures among banks — measured through metrics like the interbank ratio — greatly amplifies systemic risk, particularly during crises. Distinctively from past literature, this finding underscores the importance of ‘interconnectedness’ over bank size, whit the latter exhibiting a non-linear impact on systemic risk level. Furthermore, our findings suggest that excessive bank capital can amplify the systemic importance of institutions by fostering risk-taking behaviour among highly capitalized banks. Methodologically, our LASSO-based framework enhances variable selection by filtering out statistical noise and mitigating multicollinearity issues, thereby isolating the most relevant drivers of systemic risk. From a regulatory standpoint, our findings advocate for supervisory frameworks that explicitly integrate interbank exposure metrics into capital regulation and systemic risk assessments, thereby aligning prudential requirements with the true network-driven nature of systemic risk.