Abstract
Foreign-dominated banking sectors, such as those prevalent in Central and Eastern Europe, are susceptible to two major sources of systemic risk: (i) linkages between local banks and (ii) linkages between a foreign parent bank and its local subsidiary. During and after the global financial crisis, the second source of risk has been stressed by local regulators. Using a nonparametric method based on extreme value theory, we analyze interdependencies in downward risk in the banking sectors of the Czech Republic, Poland, Slovakia, and Turkey during 1994–2013. We find that the risk of contagion from a foreign parent bank to its local subsidiary is substantially smaller than the risk between two local banks.
7. Conclusion
In this paper we analyze the interdependencies in downside risk between local banks in Central and Eastern Europe (the Czech Republic, Poland, Slovakia, and Turkey) and between local banks and their foreign owners. We find that the risk of contagion is much stronger between local banks than between foreign parent banks and their local subsidiaries. In the analysis we use a measure of systemic risk which builds on extreme value theory. The measure is nonparametric, which allows us to account for the potentially fat-tailed distribution of shocks in financial markets, and also captures nonlinear dependencies and enables us to focus on the interdependencies between large losses of local and foreign banks. Our results suggest that the probability that a default of a local bank causes a default of another local bank is about 10%. In contrast,contagion from foreign owners is much less pronounced: a default of a foreign owner bank leads to the default of its local subsidiary with a probability of only 5%. Moreover, several observed defaults of parent banks in our sample (e.g., Fortis and Drexia) were not accompanied by defaults of their subsidiaries. Therefore, our analysis suggests that the worries of regulators in Central and Eastern Europe concerning the danger of increased systemic risk due to high foreign ownership of local banks might be exaggerated.
