Complexity, interconnectedness and stability: New perspectives applied to the European banking system

Abstract

The stability of financial markets is largely based on increased capital requirements for a list of Systemically Important Banks. The diffusion of innovative financial products across multiple markets by multi-faceted actors requires a new approach to understand the complex environment in which banks interact and identify banks that threaten the stability of the system. Using network analysis and new quantitative metrics, we address this complexity that we apply to 262 European banks. We show that the position of a bank in the network and empirical properties in its neighborhood play a major role in the stability of the system. These empirical networks have distinctive characteristics and complex forms that go beyond the well-identified categories of networks usually used in contagion scenarios. Our findings call on regulators to implement new supervisory approaches to identify banks at risk in increasingly dense networks.