International Integration, Common Exposure and Systemic Risk in the Banking Sector: An Empirical Investigation

This paper analyzes the impact of ongoing financial integration and increase in crossborder activities on banks’ common exposure to shocks and on banking sector systemic risk. For that, we study the evolution of correlations between large international banks’ asset-to-debt ratios over 1993-2006 and compute a systemic risk index for the same period. We find that banks’ common exposure to shocks has significantly decreased until 2000 and rapidly increased afterwards. Systemic risk follows a totally different pattern. No trend emerges and, instead, we observe two peaks: one in 1998 (LTCM and Russian crisis) and one in 2002-2003 (stock market downturn). These findings suggest that, contrary to a widespread belief, higher correlations between banks do not necessarily induce higher systemic risk. We then provide evidence that systemic risk is mainly driven by banks’ individual risk-taking rather than by their common exposure to risks.