Has the Global Banking System Become More Fragile Over Time?

Over the past two decades, globalization, deregulation, and financial innovations have led to significant growth of financial institutions around the world. These trends have lowered borrowing costs, improved risk diversification, and increased capital flows and productivity. But the same trends also brought those institutions closer and increased their exposure to common sources of risk. In a new working paper, Deniz Anginer and Asli Demirguc-Kunt show a significant increase in default risk co-dependence leading up to the 2008 global financial crisis. The results also suggest higher co-dependence in the banking sector of countries with more integrated or liberalized financial systems and weak banking supervision. The results lend support to more international supervisory cooperation, as well as capital charges for "too-connected-to-fail" institutions that can impose significant banking externalities. The authors reach these conclusions by examining how the correlation structure of default risk evolved for more than 1,800 banks in more than 60 countries.