On the importance of indirect banking vulnerabilities in the Eurozone

This paper investigates banking and sovereign distress in the Eurozone and the importance ofdirect and indirect financial exposures. We use BIS cross-border direct banking flows to linkmember states in a GVAR framework and jointly model sectoral CDS premia. Based on balance sheetpositions of an intermediate debtor country, we calculate indirect exposures and asses how thelevel of interconnectedness is impacted when indirect links are accounted for. We notice a generalslowdown in financial integration and a reduction in cross-border assets in the hope of limitinginternational contagion. By differentiating between direct and indirect links, we show that theimpact of reduced weights on core member states is insignificant and that deleveraging strategiesare not able to successfully reduce risk.