Financial Interconnectedness and Bank Risk-Taking: Evidence from China

Financial institutions have become increasingly interconnected. How does such financial interconnectedness affect the operation of financial institutions? This study aims to answer this question empirically by focusing on bank risk-taking via Chinese banks from 2011 to 2020. We first propose the financial network connection indicator using Granger causality network model, and then present robust evidence that risk-taking of banks is intensified with increasing financial interconnectedness. Moreover, the heterogeneous analysis is found that banks’ digitization transformation, countries’ better law enforcement, and strict regulation will mitigate the nexus between financial interconnectedness and bank risk-taking, while government aid, loose monetary policy, and greater economic policy uncertainty will intensify the above effect. We also find that financial interconnectedness may affect banks’ risk-taking through increasing banks’ shadow business and profit fluctuation and changing bank market structure. These findings could have essential policy implications for both banks and financial regulators.