The systemic risk of European banks during the financial and sovereign debt crises

We propose a hypothetical distress insurance premium (DIP) as a measure of the European banking systemic risk, which integrates the characteristics of bank size, default probability, and interconnectedness. Based on this measure, the systemic risk of European banks reached its height in late 2011 around ? 500 billion. We find that the sovereign default spread is the factor driving this heightened risk in the banking sector during the European debt crisis. The methodology can also be used to identify the individual contributions of over 50 major European banks to the systemic risk measure. This approach captures the large contribution of a number of systemically important European banks, but Italian and Spanish banks as a group have notably increased their systemic importance. We also find that bank-specific fundamentals predict the one-year-ahead systemic risk contribution of our sample of banks in an economically meaningful way.