Are banking shocks contagious? Evidence from the eurozone

We analyze the transmission of shocks between global banking, domestic banking and the non-financial sector for eleven Eurozone countries. Using a Markov-switching Factor augmented VAR model, we dis- tinguish between contagion, interdependence and decoupling as shock transmission mechanisms during the ‘crisis’ regime. Contagion played a role in propagating global banking shocks to the banking sectors of smaller states, exacerbating the crisis in these countries. In contrast, the non-financial sectors suffered lit- tle contagion from either external or domestic banking shocks, and generally managed to decouple from the banking industry –indicative of being able to source alternative financing and shield themselves from the crisis. However, shocks originating in the non-financial sector trigger contagious effects for both the domestic banking sector and, to a lesser extent global banking, thereby acting as a source of fragility for the financial sector during crisis periods