Bank systemic risk and the business cycle: Canadian and U.S. evidence

This paper investigates how banks, as a group, react to macroeconomic risk and uncertainty, and more specifically the way banks systemic risk evolves over the business cycle. Adopting the methodology of Beaudry et al. (2001), our results clearly suggest that the dispersion across banks traditional portfolios has increased through time. We introduce an estimation procedure based on EGARCH and refine Baum et al. (2002, 2004, 2009) and Quagliariello (2007, 2009) framework to analyze the question in the new industry context, i.e. shadow banking. Consistent with finance theory, we first confirm that banks tend to behave homogeneously vis-à-vis macroeconomic uncertainty. In particular, we find that the cross-sectional dispersions of loans to assets and non-traditional activities shrink essentially during downturns, when the resilience of the banking system is at its lowest. More importantly, our results also suggest that the cross-sectional dispersion of market-oriented activities is both more volatile and sensitive to the business cycle than the dispersion of the traditional activities.