Spillover Effects from External Shocks on Bank Credit Risk: Evidence from Cointegration Analysis for Albania

Over the last fifteen years, the presence of European banking groups in the banking systems of Western Balkan countries, has negatively affected their financial stability through external economic/financial shocks. Albania is an example of a Western Balkan country, with a significant foreign capital presence in its banking system, including Italian capital. Furthermore, Albania is economically linked to Italy through trade channels and remittances arriving from Albanian immigrants in Italy. Given that Italy has been one of the main protagonists of the European debt crisis (2010-2012), the chance of negative spillover effects from the Italian debt crisis, transmitted to the Albanian banking system through banking and trade channels, is high. Despite this, no previous studies have attempted to incorporate these potential effects in the empirical analysis. Employing the ARDL approach to cointegration (and the VECM framework as a complementary method), this paper investigates the determinants of credit risk in the Albanian banking sector paying particular attention to the spillover effects from external shocks. Empirical findings suggest that the Italian debt crisis has a positive impact on bank credit risk in Albania over the period 1999Q1–2019Q4. Moreover, it is concluded that other country-specific factors such as the real effective exchange rate and the capital to assets ratio positively affect credit risk in Albania.