Interconnectedness of the banking sector as a vulnerability to crises

This paper uses macro-networks 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, macro-networks also account for financial linkages to the other main financial and non-financial sectors within the economy. We enrich conventional early-warning models using macro-financial vulnerabilities, by including network measures of banking sector as potential determinants of banking crises. Our results show 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, the results show that early-warning models augmented with interconnectedness measures outperform traditional models in terms of out-of-sample predictions of recent banking crises in Europe.JRC.G.1-Financial and Economic Analysi