European Banking Distress and EMU : Institutional and Macroeconomic Risks

Financial stability in Europe has received renewed attention with the advent of a common currency, wave of mergers and acquisitions among financial institutions, and greater market competition (e.g. ECB, 1999; IMF, 1999; OECD, 1999). This paper examines whether EU country banking systems are particularly vulnerable to systemic risk at present. Our approach is to examine episodes of banking sector distress for a large sample of countries, highlighting the experience of the EU. We estimate multivariate probit models linking the likelihood of banking problems to a set of macroeconomic variables and institutional characteristics. Institutional characteristics, made available by a new data set on corporate governance in the financial sector not previously used in this type of analysis, include aspects of bank supervision and regulation, restrictions on bank portfolios, and development of the banking system. Given these characteristics, the model predicts a low probability of banking sector distress in EMU countries. *This paper was prepared for the workshop “Structural Change and European Economic Integration,” held at Liseleje, Denmark on 10-11 September 1999, sponsored by the Economic Policy Research Unit of the University of Copenhagen. Valuable comments by workshop participants and research assistance from Kathleen McDill are gratefully acknowledged. SCCIE WORKING PAPER #99-1 Santa Cruz Center for International Economics http://www2.ucsc.edu/cgirs/sccie