Banking Stability: The Impact of Financial Sector Heterogeneity on Systemic Risk in Financial Crises and Economic Recessions

Banking Stability: The Impact of Financial Sector Heterogeneity on Systemic Risk in Financial Crises and Economic Recessions

Carlos León, Zihao Liu, Luc Renneboog

Series number :

Serial Number: 
863/2022

Date posted :

December 21 2022

Last revised :

December 21 2022
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Keywords

  • Financial institutions • 
  • Bank holding companies • 
  • COVID-19 • 
  • Great Recession • 
  • FDIC • 
  • financial markets • 
  • financial crises • 
  • Economic Recessions • 
  • Heterogeneity; Systemic risk • 
  • Dodd Frank

Financial institutions’ heterogeneity, a high degree of dissimilarity across multiple dimensions, including business focuses, correlated asset holdings, capital structures, and funding sources, can reduce systemic risk.

We empirically test this hypothesis using a bank holding company (BHC) level heterogeneity index based on granular balance-sheet, income statements, cash flow statements, and off-balance-sheet information for the U.S. bank holding companies over a sample period spanning the second quarter of 2000 to the fourth quarter of 2021. We find that the BHC-level heterogeneity negatively correlates with BHC-level systemic risk, SRISK, measured both at the global and local level. We also construct a sector-heterogeneity index and demonstrate that a reduction of heterogeneity occurred in the U.S. financial sector prior to both the Great Recession (2007-2009) and the COVID-19 Recession, especially for the largest bank holding companies (BHCs). As such, a declining level of financial sector heterogeneity may exacerbate the consequences of systemic shocks.

Published in

Published in: 
Publication Title: 
Forthcoming book chapter (World Scientific Publishing)
Description: 
Forthcoming book chapter Banking Resilience and Global Financial Stability, Boubaker and Elnahass (eds.) (World Scientific Publishing)

Authors

Real name:
Carlos León
MSc.
Real name:
Zihao Liu
Finance