Research in International Business and Finance 51 (2020) 101017

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Research in International Business and Finance

journal homepage: www.elsevier.com/locate/ribaf

Bank risk, competition and bank connectedness with firms: A

T
literature review
⁎
Cristina Badaraua, Ion Lapteacrub,
a
Larefi, Department of Economics, University of Bordeaux and INFER, Avenue Léon Duguit, 33608 Pessac, France
b
Larefi, Department of Economics, University of Bordeaux, Avenue Léon Duguit, 33608 Pessac, France

A R T IC LE I N F O ABS TRA CT

Keywords: The outbreak of the 2007–2009 financial crisis and of the European sovereign debt crisis again
Banking competition raised questions about the vulnerability and the behaviour of banking institutions. The un-
Bank risk conventional monetary policies that followed have flattened the yield curve and created a low
Bank connectedness with firms interest rates environment. This can give rise to risk-taking behaviour from banks and can
Systemic risk
therefore undermine the stability of the banking system with negative impact of the credit
JEL classification: supply, corporate investment and real economy. This article proposes a literature review on the
E44 main determinants of bank lending and risk-taking decisions, going through the competition in
G21
the banking market, the bank connectedness with firms and the role of monetary and banking
G28
authorities. The systemic risk concept is also discussed as well as its drivers and potential
G32
measures that should be monitored by prudential authorities in order to preserve financial sta-
bility.

1. Introduction

The Global Financial Crisis (GFC) of 2007–2009 impacted the risk-taking behaviour of banking institutions but also their re-
lationship with firms. To fight against economic downturn that followed, monetary authorities have drastically lowered their interest
rates keeping them near or below zero for a long time, even for too long time. Such a too-low-interest rate environment eroded the
profits and net-interest-margin of banks, emphasizing hence the risk-taking channel in the conduct of monetary policy. According to
search-for-yield mechanism, banking institutions are encouraged to invest in high-yield but risky financial assets (Rajan, 2005)
distorting their relations with firms. Small and medium-sized enterprises (SME) had difficulties accessing bank financing, even for
firms involved in long-term and trust relationship with their main bank. Such a relationship may be destroyed or, at least, over-
shadowed because of both banks and firms’ vulnerability. Vulnerable banking institutions would want to share the risk and prefer the
firms with multiple banks, especially for large loans (Carletti et al., 2007). Moreover, vulnerable firms may also prefer multiple
banking relationships to reduce the risk of credit rationing (Detragiache et al., 2000) and the interest rates of loans (Carletti et al.,
2007).
Other issues, among many others, highlighted by the changes of the banking environment are related to the role of banks’
competitive and risk-taking behaviour in their functioning strategies. Market power of banks, or their competitive behaviour, may
impact not only their activities (traditional and non-traditional ones) (Nguyen et al., 2012) but also their financial performances,
especially net interest margins and profits (Berger and Ofek, 1995; Demirgüç-Kunt and Huizinga, 1999) that are also affected by the
risk-taking behaviour of banks (Alshatti, 2015; Boadi et al., 2016; Bhattarai, 2016). This last behaviour changed a lot during and after

⁎
Corresponding author.
E-mail addresses: florina-cristina.badarau@u-bordeaux.fr (C. Badarau), ion.lapteacru@u-bordeaux.fr (I. Lapteacru).

https://doi.org/10.1016/j.ribaf.2019.03.004
Received 1 February 2019; Accepted 8 March 2019
Available online 16 March 2019
0275-5319/ © 2019 Elsevier B.V. All rights reserved.
C. Badarau and I. Lapteacru Research in International Business and Finance 51 (2020) 101017

the GFC and hence the regulation and supervision approaches of banking regulators. The banking authorities became more prudent
and provided a more rigorous and stringent banking regulatory environment, enforcing all levels of micro-prudential regulation,
completing them, and adding a macro-prudential component. They unveiled the Systemically Important Financial Institutions (SIFIs),
monitor and supervise them better and impose to them even more restrictive regulation constraints. The concept of systemic risk has
been for the first time studied so plentifully and a lot of its measures are conceived and proposed since the GFC. Most of them are
based on market data and unveil the SIFIs through their impact on market downturn (Acharya et al., 2012, 2017; Adrian and
Brunnermeier, 2016; Brownlees and Engle, 2017). All of them are in sights of researchers and banking regulators, especially because
many regulatory reforms changed not only the individual risk of banks but also the systemic risk of banking industry.
This paper aims at providing some insights on these different issues related to changes in competitive and risk-taking behaviour of
banks, to their relationships with firms and to the impact of central bank's attitude on the risk of the banking system. We therefore
propose a literature review focused on three main issues: (1) competitive behaviour of banks, their diversification strategy and their
connectedness with firms; (2) factors of risk-taking behaviour of banking institutions; and (3) main measures of systemic risk and
their main determinants. We also introduce five articles that represent an innovative contribution in these three research fields. They
have been selected following the 19th Annual Conference of INFER (International Network For Economic Research), held in
Bordeaux, from 7th to 9th June 2017. Bogdan Capraru, Iulian Ignatov and Nicoleta Pintilie, in their article “Competition and di-
versification in the European banking sector”, study the impact of banks’ competitive behaviour on their strategy of diversification.
Cathérine Refait-Alexandre and Stéphanie Serve, in their article “Multiple banking relationships: Do SMEs mistrust their banks?”,
wonder about the factors that push firms in engaging in single or multiple banking relationships. Alexandra Campmas, in her article
“How do European banks portray the effect of policy interest rates and prudential behaviour on profitability?”, investigates the role of
the monetary policy and banks’ prudential behaviour in the profitability of banking institutions. Applying the most used systemic risk
measures, Sonia Dissem and Frederic Lobez in their article “Correlation between the 2014 EU-wide stress tests and the market-based
measures of systemic risk” try to gauge the importance of systemic risk indicators in the uncovering of SIFIs by the European
authorities. Finally, Alin Andries, Simona Nistor and Nicu Sprancean in their article “The impact of Central Bank transparency on
systemic banks. Evidence from Central and Eastern Europe” highlight the relationship between central bank transparency and sys-
temic risk of the banking industry.
Therefore, the structure of the paper follows the investigation of these three research fields. The second section provides the main
measures of bank competition, describes its effects on banks’ behaviour, especially on diversification of their activities, and highlights
the main factors that push firms to have single- or multiple-banking relationships. The third section discusses the main causes that
encourage banks to take on more risk, but also the effect of such a behaviour on their financial results. Some insights are also
addressed to the role of the monetary policy, which changed a lot after the GFC. The fourth section describes the main measures of the
systemic risk in banking, which has been also employed to uncover the SIFIs. Not only have their determinants been provided, but
also the role of monetary and banking authorities. We provide the main conclusions of this literature review in the last section.

2. Bank competition, diversification and connectedness with firms

The competition in the banking industry has been widely studied in terms of concepts and measures, but also concerning the way
it impacts banks’ behaviour and the functioning of the entire financial system. The results of the literature often relate competition to
decisions regarding product diversification and banks’ risk-taking, emphasizing the difference of results obtained with different
concepts of bank competition.
Two main approaches are considered when defining and measuring competition in the banking system. Although generally
applied in a complementary and interchangeable way, they are fundamentally different and sometimes provide opposite results. The
so-called structural approach provides competition measures issued from the structural characteristics of the market, as the market
share of the largest banks or the Herfindahl–Hirschman concentration index (HHI). The application of concentration measures to
gauge competition is supported by the Structure-Conduct-Performance (SCP) paradigm (Bain, 1951). The second approach related to
the so-called “new empirical industrial organization” is linked to the idea that competition measures should be issued from economic
explanations of bank behaviour, especially when concentration measures fail to gauge competition on contestable markets (Baumol
et al., 1982). The most applied measures are the H-statistic of Panzar and Rosse (1982, 1987), the Lerner (1934) index and, more
recently, the Boone (2008) indicator. The H-statistic measures the competitive behaviour of banks by the reaction of their revenue to
the evolution of their input prices. The Lerner index determines the mark-up of banks’ price over their marginal cost and the Boone
indicator determines also the market power through the elasticity of profits (or market share) with respect to marginal costs.
Therefore, all competition (market power) measures widely applied in the banking literature are conceptually very different and,
for instance, Lapteacru (2014) shows mathematically and confirms empirically on Central and Eastern European banks how and in
which conditions HHI, the H-statistic and the Lerner index may provide opposite results. Using the frontier analysis, Bolt and
Humphrey (2015) come to the same conclusion that these measures cannot be used interchangeably. More concentrated banking
market may lower bank competition (Khan et al., 2017), but, in the same time, may provide a better access to bank deposits and loans
(Owen and Pereira, 2018).
Hence, one should be careful on the concept of competition one applies, since it is an important factor on banks’ financial results
and behaviour. For instance, the relationship between competition and profitability has been studied a lot and provided mixed
results. Tan (2016) makes an empirical analysis on Chinese banks and concludes that there is no influence of competition on
profitability, which is partly sustained by Pasiouras and Kosmidou (2007) for European banks. On the other side, Dietrich and
Wanzenried (2014) put in evidence that bank concentration has a positive influence on the profitability measured in terms of return

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on average assets and return on average equity. The explanation consists in the decision of largest banks of not undertaking excessive
risks. Mirzaei et al. (2013) also provides evidence on a positive relationship between market power and profitability.
The competition (or the market power) impacts not only the banks’ financial results but also their functioning. The bank lending
activity is strongly depending on the bank competition. In normal time, credit supply from banks with higher market power is less
sensitive to the central bank interest rate, allowing a more sustained lending activity in periods of tight monetary policy (Lapteacru,
2010; Fungacova et al., 2014; Leroy and Lucotte, 2014). Fungacova et al. (2017) analyse the effect of the competition on the cost of
credit and their results are in the sense that bank competition increases the cost of credit, especially in small companies. The effect
seems to be weaker in crisis periods. Gonzales (2016) however observes that in banking systems with stronger competition and
creditor rights protection, corporate investments had a deeper decrease during the crisis. Saaskilahti (2016) also observes a decrease
in the volume of new business loans and higher average loan margins for the Finnish cooperative banks after the onset of the financial
crisis. Horvath et al. (2016) analyse the effect of competition on a sample of Czech banks and conclude that higher competition is
associated with bank fragility and leads to reduced liquidity creation. Moreover, Leon (2015) proves that when competition is
considered in terms of bank efficiency, it alleviates credit constraints leading to less severe loan approval decisions and reducing
borrower discouragement.
Many papers are focused on the important topic of the impact of competition on lending, according to different targets, but there
are only a few ones that emphasizes its important role in diversification, in general, and in carrying out non-interest income activities,
in particular. It is a very important subject too, since the diversification is strongly related to profitability of banks (Mirzaei et al.,
2013) and impacts the competition-profitability nexus (Maudos, 2017), but also because it can be a stabilising factor for the banking
system. Bodgan Capraru, Iulian Ignatov and Nicoleta Pintilie, in their article “Competition and diversification in the European
banking sector”, published in this special issue, show that competition really stimulates diversification activities of European banks,
broadening the number and type of both non-interest earning balance-sheet activities and off-balance sheet items. Based on a very
large sample of 1570 commercial banks from all 28 European Union member states they find over 2000–2016 period that the
European banks with lower market power are oriented to additional income sources and have higher non-interest income ratios.
Beyond competition, many other factors that influence the bank lending activity were studied, but a little attention has been paid
on the banks’ connectedness with firms, especially with Small and medium-sized enterprises (SME) that are strongly linked to bank
financing. Because SMEs are strongly dependent on banks, they may be credit rationed and/or face harsh financial constraints, which
may slow down and even curb the economic growth. This important issue is scarcely studied, emphasizing the need for banks to hold
a single versus multiple bank relationships. According to the financial theoretical literature on banking relationships, the decision to
have a single or several banks depends on the asymmetry information between banks and firms. More precisely, the use of a single
versus several banks impacts the way banks monitor their debtors, by creating economies of scale, monopoly rents or by encouraging
free-riding in monitoring (Sharpe, 1990; Carletti, 2004). The single bank may be preferred in the virtue of a long-term relationship,
which helps to mitigate asymmetric information (Boot, 2000) and may therefore facilitate the access to credit market for firms at
lower costs. Sette and Gobbi (2015) and Bolton et al. (2016), for example, show the effectiveness of relationship lending in smoothing
fluctuations in credit and in providing liquidity insurance to firms, even during crises. Banerjee et al. (2017) study the real con-
sequences of relationship lending on firm activity in Italy following the recent financial and European Debt crises. They find that
banks offered more favourable lending terms to firms with which they had stronger relationships, allowing them to maintain higher
levels of investment and employment.
Holding multiple relationships may also be beneficial. When a firm borrows simultaneously from multiple banks, it has a credible
outside option and improves its bargaining power (Sharpe, 1990; Rajan, 1992; Ioannidou & Ongena, 2010). Multiple bank re-
lationships also allow banks to share monitoring costs (Carletti et al., 2007). Thus, they may prefer multiple-bank lending when they
have lower equity, when the cost of monitoring is high, or when the profitability of their debtors is low. Bonfim et al. (2018) use a
unique dataset that covers all bank loans granted in Portugal and find that when a small firm borrows from one additional bank, the
interest rate on its bank loans decreases. This is mainly due to the fact that multiple bank relationships reduce asymmetric in-
formation related to the financial contract for small firms.
Deeper insights are provided by Catherine Refait-Alexandre and Stéphanie Serve in their article “Multiple banking relationships:
Do SMEs mistrust their banks?” published in this special issue. The authors put into perspective both financial and management
approaches in explaining the probability of SMEs engaging in single or multiple banking relationships. Firstly, they find that some
firms’ characteristics play a role in decision to engage in multiple banking relationships. Larger and high-performing firms are more
likely to develop multiple banking relationships to themselves from the extraction of informational rent by main banks. More in-
novative SMEs are also incentivized to have several banks, probably because, as argued by the authors, they should share the higher
risk they exhibit having, in the same time, few tangible assets. Secondly, as the authors have a variable describing the willingness to
build relational trust, they use it in regressions to test the alternative theoretical framework based on the concept of relational trust
from CEOs. They find a very interesting result that explains the relationship between managers’ behaviour and multiple banking
lending. When the managers are focused on lowest interest rates, they are more likely to develop multiple banking relationships
benefiting from competition between banks. Conversely, when the managers want to develop long-term bank relationships, they are
more likely to develop relationships with a single bank.
Both published papers in this special issue by Bogdan Capraru, Iulian Ignatov and Nicoleta Pintilie or Catherine Refait-Alexandre
and Stéphanie Serve, tackle the main issues related to the impact of competition and bank relationship with firms on banking
institutions’ behaviour regarding their diversification and pricing strategies. Such a behaviour may also be caused by or leads to an
excessive risk-taking. Banks involved in less diversified activities are found to be riskier, because the risk is shared between fewer
activities, and, vice versa, riskier banks could concentrate their investments in less risky assets in order to reduce their riskiness.

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Likewise, a single bank may build a long-term relationship and hence reduce the asymmetry of information, reducing the probability
of failure, and, vice versa, due to a risk of failure, banks would want to share the risk and incentivize the firms for multiple banking
relationships.

3. What drives bank risk-taking?

Therefore, the risk-taking behaviour can be caused by a certain competitive behaviour or by a certain market power of banks. Two
approaches emerge from the banking literature. According to the competition-fragility paradigm, within a high competition en-
vironment banks are seeking for additional income sources and therefore adopt a more aggressive risk-taking behaviour investing in
riskier assets. They engage in activities that promise higher returns either to compensate the loss of their franchise value (Marcus,
1984; Keeley, 1990) or to keep or increase their capital buffers (Allen and Gale, 2004; Boyd et al., 2004). The riskiness of banks is also
exacerbated by the unwillingness of banking institutions to provide liquidity to their vulnerable counterparts (Allen and Gale, 2000)
and, more generally, to support interbank cooperation and assistance (Saez and Shi, 2004). Higher competition reduces also the
amount of information the banks can collect (Hauswald and Marquez, 2006), thus increasing the risk of loan defaults. These different
theoretical findings were confirmed empirically on both developed and developing banking markets. This competition-fragility
theory applies for the Turkish banking system (Kasman and Kasman, 2015), for Latin American (Yeyati and Micco, 2007), Asian (Liu
et al., 2012; Fu et al., 2014) and transition (Agoraki et al., 2011; Lapteacru, 2017) banking markets, for European banks (Leroy, 2017)
or, globally, for developed and developing countries (Diallo, 2015). Competition is found to affect not only the individual risk of
banks but also the systemic risk because of correlations between banks’ risk-taking decisions.
The arguments in support of the competition-stability paradigm are not less numerous and less convincing. Some of them plead in
favour of more competitive banking market, because within a weak competitive environment the banks are encouraged to increase
their interest rates and thus to originate riskier and of larger amount loans (Caminal and Matutes, 2002; Boyd and De Nicoló, 2005).
Moreover, such banking institutions are more predisposed to adopt a “too-big-to-fail” behaviour (Mishkin, 1999, 2006; Barth et al.,
2012) that threatens the stability of the banking system. The empirical studies support these theoretical arguments and provide other
evidence on the positive impact of competition on stability of banking system depending also on regulatory, economic environment
and business strategies of banks. Beck et al. (2013) concludes that competition has more positive effects in better regulated and less
fragile financial systems and in countries with more developed capital markets. Focusing on the correlation between individual risk of
banks, Anginer et al. (2014) provide evidence on a negative relationship between competition and the systemic risk and they explain
their findings by the diversification, which leads to stability, that banks are encouraged to do on a competitive market. The same idea
is supported by Fiordelisi and Mare (2014) for European cooperative banks, applying a Grainger causality test to analyse the short-
run and the long-run impact of competitiveness on financial stability over the 1998–2009 period, and by Goetz (2018) for US banks,
concluding that competition increases bank stability as it decreases the ratio of non-performing loans. As for the competition-fragility
paradigm, it is also confirmed for emerging and developing countries. Clark et al. (2018) confirm the competition-stability view in
CIS countries. On a large sample of emerging countries, Amidu and Wolfe (2013) show that competition increases diversification on
both interest and non-interest income generating activities leading to a decrease of the insolvency risk of the banks, which is also
supported by Soedarmono et al. (2013) who show that higher market power is associated with higher income volatility and in-
solvency risk.
Many papers found an intermediate result and conciliated the two paradigms. The relationship between bank competition and
risk may change because of changes of economic environment, of banking market or of banks’ strategies and behaviour. Martinez-
Miera and Repullo (2010) identify a non-linear relationship between competition and stability, which depends on the concentration
in the banking market. In competitive environments, increased competition leads to higher fragility, but it reduces the risk on more
concentrated markets. A non-linear relationship is also found by Aysun (2018) and Jimenez et al. (2013), the latter pointing out, on a
sample of Spanish banks, that the relation between competition and risk-taking on the loan market is convex and it is concave on the
deposit market. Tan and Floros (2018) in a study on Chinese banks conclude that greater competition decreases credit and insolvency
risk, but increases the liquidity risk.
The competition is not the only factor that influences the risk-taking behaviour of banks, since corporate governance, institutional
environment or national culture, among many other factors, may impact the financial stability of banks. Anginer et al. (2018) find
that shareholder-friendly corporate governance results in higher risk for larger banks and for banks that are located in countries with
generous financial safety nets, as banks try to shift risk toward taxpayers. As for institutional environment, Ashraf (2017) documents
that sound political institutions stimulate higher bank risk-taking, which is consistent with the hypotheses that better political
institutions increase banks’ risk by boosting the credit market competition from alternative sources of finance (see also Qi et al., 2010;
Boubakri et al., 2014) and hence generate moral hazard problems due to the expectation of government bailouts during downturns
(Dam and Koetter, 2012; Cukierman, 2013). On the other side, an opposite conclusion is also supported in the literature based on the
idea that better political institutions lower government expropriation risk (Haber et al., 2008; Liu and Ngo, 2014) and information
asymmetries between banks and borrowers (Bushman et al., 2004). And the way in which the banks are saved affects also their risk-
taking incentives, because bailout policies induce excessive risk-taking on more competitive banking market (Shy and Stenbacka,
2017). Even structural and institutional factors like national culture values and trust (Mourouzidou-Damtsa et al., 2017) as well
financial integration impact the risk-taking of banks. The risk profile of banks is also different according to their ownership, foreign
banks being generally less risky than their counterparts (Chen et al., 2017a; Lapteacru, 2018). Moreover, Wu et al. (2017) argue that
the presence of foreign banks fosters the risk of domestic banking institutions. Another important aspect that was studied is the
opacity of bank activities. If it is unanimously agreed that bank opacity encourages risk-taking (Fosu et al., 2017; Jungherr, 2018), the

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impact of competition on this effect is mixed. Jungherr (2018), for instance, shows that fiercer competition leads to more trans-
parency and hence to less risky activities, while Fosu et al. (2017) establish that competition amplifies the negative effect of opacity
on bank risk-taking.
Among institutional factors, monetary decisions to keep interest rates too low for too long are viewed as one of the most sig-
nificant, contributing to excessive risk-taking by financial institutions (Borio and Zhu, 2012; Dell’Ariccia et al., 2014, 2017; Angeloni
et al., 2015; Brana et al., 2018), including in emerging countries (Chen et al., 2017b).1 Nonetheless, the accommodative monetary
policy may also generate compensating effects. Low interest rates might raise the net interest margins for banks and increase their
profits, thus alleviating the moral hazard problem and limiting the risk-taking (De Nicolò et al., 2010). Moreover, low interest rates
may reduce the default risk of borrowers and thus increase bank profitability and reduce the bank risk (Agur and Demertzis, 2012).
These theoretical findings are not really supported by empirical studies that conclude on opposite effect (Genay and Podjasek, 2014,
Busch and Memmel, 2017, Claessens et al., 2017). A non-linear impact can be also considered (Borio et al., 2017).
A precision on mixed effect of an accommodative monetary policy on banks’ profitability is also provided by Alexandra Campmas
in her article “How do European banks portray the effect of policy interest rates and prudential behaviour on profitability?”, pub-
lished in this special issue. Based on a large panel of 445 European banks, she finds, and her results are supported by many robustness
checks, that such a monetary policy attitude pushes net interest margins of banks downwards and globally worsens their overall
profitability. And this impact is even stronger for riskier banks, which themselves have lower returns and profits. Thus, Alexandra
Campmas raised both monetary policy and prudential issues. Within too-low-for-too-long interest rate environment, banks are en-
couraged to increase their trading riskier activities, in spite of traditional less risky ones, threatening thus financial stability. And her
study supports the implementation of microprudential measures aiming at strengthening the banks’ ability to absorb losses through a
higher quality of their capital, which does not worsen their profitability.
Finally, prudential regulation plays a very important role in risk-taking behaviour of banks, especially after the 2007–2009
financial crisis. It was strongly strengthened and a macroprudential component has been added in order to temper the risk appetite of
banks and make the banking system safer. Besides microprudential tools, this second component aims at fighting against the systemic
risk accumulation. More restrictive prudential requirements led banks to adapt their strategies and risky activities. They increased
their capital ratios (Cohen and Scatigna, 2016), by lowering dividend payouts and by widening lending spreads that allowed to retain
more earnings. Even though the reaction of banks to the implementation of the macroprudential component is found to be different
according to their size, capitalisation and wholesale funding ratios (Altunbas et al., 2018), it is unambiguously related to risk im-
proving profile of banks with respect to all macroprudential tools, especially the liquidity ratio (Banerjee and Mio, 2018).

4. From individual to bank systemic risk

The effects of the 2007–2009 Global Financial Crisis emphasized the deficiency of the concept of individual bank risk for insuring
financial stability and the concept of systemic risk has been added for exploration and monitoring. In order to preserve financial
stability of the banking system as a whole, financial authorities need to assess determinants of the systemic risk and identify sys-
temically important institutions. A large strand of the literature focused on this subject, emphasizing the role of banks in the stability
of the entire banking system that depends on their size, leverage, credit risk, non-interest income, liquidity of funding structure
(Bisias et al., 2012; Laeven et al., 2016). But most important determinants of the systemic risk are the regulatory regime and the
interconnectedness between banks. The former is well proven by Weiß et al. (2014) and the latter is the topic of numerous studies.
Barroso et al. (2018) show that the network topology, which characterise the interconnectedness between banks, explains most of the
systemic risk development, while the capital buffer explains the persistent reduction in systemic risk buildup with effects con-
centrated around the global financial crisis. Paltalidis et al. (2015) investigate systemic risk and financial contagion on European
banking system and show that systemic risk within the northern euro area banking system is less apparent, while the southern euro
area banking system is more prone and susceptible to bank failures provoked by financial contagion. Cai et al. (2018) develop a
measure of bank interconnectedness using syndicated corporate loan portfolios, overlap based on industry and region, and find that
interconnectedness is driven mainly by bank diversification, less by bank size or overall loan market size. Contrary to them, Varotto
and Zhao (2018) highlight the important role of the size in explaining the systemic risk indicators for US and European banks, which
implies an overriding concern for ‘too-big-to-fail’ institutions, but show that smaller banks may pose considerable systemic threats,
which is also found by Wang et al. (2018) for Chinese banks.
The need to focus on the systemic risk, either to unveil the SIFIs or to determine its factors, mobilised the researchers in banking to
conceive measures to estimate it. Many concepts are proposed with different objectives. Lo Duca and Peltonen (2013) use a Financial
Stress Index for identifying the starting date of systemic financial crises, applying a discrete choice model that combines both
domestic and global indicators of macro-financial vulnerabilities. Drehmann and Juselius (2014) find that credit-to-GDP gap ratio
and the debt service ratio are the best predictors of systemic risk. Nonetheless, they didn’t provide a real measure of systemic risk.
Many proposals have been made recently and all of them are based on market data; more precisely, on evolution of returns of banks’
stocks. Most known and mostly applied are marginal expected shortfall (MES) constructed by Acharya et al. (2017), the delta
conditional value at risk (ΔCoVaR) of Adrian and Brunnermeier (2016) and the systemic risk indicator (SRISK) of Acharya et al.
(2012) and Brownlees and Engle (2017). The first systemic risk measure assesses the performance of a bank when the market as a
whole experiences its worst trading days in the year. Hence, the MES measures the rise in the risk of the banking system due to a

1
Chen et al. (2017a,b) provide a very nice literature review on the different ways the monetary policy impacts banks’ risk-taking decisions.

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marginal increase in the weight of a bank in the system. The greater the bank's MES, the greater the individual contribution of this
bank to the risk of the banking system as a whole. The conditional VaR (CoVaR) describes the contribution of an individual bank to
the VaR (Value-at-Risk) of the banking industry. Consequently, the ΔCoVaR measures the difference between the CoVaR conditional
on the bank being under the pressure (5% of worst losses) and the CoVaR in the normal state (median losses) of the bank. The SRISK
allows to measure the capital that a financial institution would need to raise in the cases of troubles. Hence, according to their
concepts and methodologies, the three risk measures permit to unveil SIFIs.
Some extensions and, potentially, improvements have been proposed. Liu (2017) generalizes the CoVaR approach previously
proposed by Adrian and Brunnermeier (2016) in order to allow it switching between a high and a normal risk regime. He also
provides a new significance test to identify SIFIs, and a stochastic dominance test to rank the identified SIFIs. The comparison with
the previous CoVaR measure shows that the original measure underestimates the contributions of SIFIs to the risk of entire financial
system, but overestimates the contribution of non-SIFIs. As an alternative measure of systemic risk, Black et al. (2016) suggest a
distress insurance premium (DIP), which integrates the characteristics of bank size, probability of default, and correlation. Using a
structural model of individual bank defaults across the banking sector with banks that are interconnected through their exposure to a
common risk factor, Kreis and Leisen (2018) propose a systemic risk measure based on the default frequency in the banking sector.
Working with a network of financial market infrastructures, Li and Perez-Saiz (2018) measure the systemic risk as the probability that
two or more financial market infrastructures have a large credit risk exposure to a common participant.
These different extensions either deal with some shortcomings of original systemic risk measures or account for other aspects. In
spite of some shortcomings, these systemic risk measures predict well and unveil correctly SIFIs. Sonia Dissem and Frederic Lobez in
their article “Correlation between the 2014 EU-wide stress tests and the market-based measures of systemic risk”, published in this
special issue, compare the results of the European Banking Authority (EBA) stress tests with these systemic risk measures and find
that the SRISK is the best predictor of systemic risk, since it is the most correlated with the stress test results. However, all measures
are explicative of the capital shortfall and the total losses provided by the EBA.
To end up, many factors are found to influence both individual and systemic risk of banks and some of them are presented above.
Being either specific to banks, institutional, cultural or related to banking market, economic environment and monetary policy, they
unveiled the most important fragilities of banking institutions. Alin Andries, Simona Nistor and Nicu Sprancean in their article “The
impact of Central Bank transparency on systemic banks. Evidence from Central and Eastern Europe”, published in this special issue,
highlight another very important aspect, to which was paid very little attention. The central bank transparency has been studied as
the effect in stock market volatility (Chortareas et al., 2002; De Mendonça and Filho, 2007; Demertzis and Hughes Hallett, 2007;
Reeves and Sawicki, 2007; Dincer and Eichengreen, 2014) and on the term-structure of interest rates (Andersson et al., 2006), but
Alin Andries, Simona Nistor and Nicu Sprancean go further putting it in the relationship with individual and systemic risk of banks.
Based on the experience of Central and Eastern European banks, they find that more central bank transparency reduces the individual
risk of banks, but increases individual contribution to the risk of the entire banking system. However, this harmful effect can be
reduced with the independency of the central bank and in the context of a strong regulatory environment.
All these measures, their extensions, improvements and developments proved their efficacy and therefore usefulness in the
monitoring of the safety and the fragility of banks, individually, and banking system, as a whole. As suggested by Acharya et al.
(2014), they should be taken into account for evaluation, monitoring and regulatory policies of baking regulators and supervisors.

5. Conclusion

This article proposes a brief literature review seeking to collect the more relevant recent contributions in the areas of Bank Risk,
Competition and Bank Connectedness with Firms. We denote here the three main determinants of banks’ activities, with strong
impact on firms’ financing and, in turn, on economic activity. Indeed, banks that decide to take more risk extend their lending
activity. More competition among banks is also usually associated to larger banks lending activity. From the point of view of firms,
firms implicated into long-term relationships with their bank may benefit of easier access to credit. However, some firms can improve
their financial conditions by borrowing simultaneously from multiple banks, taking benefit from the competition in the banking
market. It is also to be noted that the three above mentioned factors are not independent. For instance, competition on the banking
market is without doubt determining the banks’ risk taking behaviour, but the sign of this relationship remains uncertain in the
literature. Following the competition-fragility paradigm, banks would seek for additional income sources and would take more risk in
a highly competitive environment, so competition would not really be suitable. Opposite to it, the competition-stability paradigm
provides evidences that instability is more related to a weak competitive environment, because important banks are encouraged to
increase their interest rates and thus to attract riskier loans. In a banking system where small and important banks coexist and
interact, the last ones are even more encouraged to take risk, being guided by their willingness to become ‘too-big-to-fail’. Given their
interconnections with the other banks, they become SIFIs, generating systemic risk and unsuitable financial instability. Since 2007,
the literature on systemic risk developed quickly, as emphasized by Silva et al. (2017). The last part of our literature review focused
only on the identification of determinants and potential measures of systemic risk, key elements for the design of an efficient
prudential regulation. Such measures should take into account not only the evolution of returns of banks’ stocks, but also the default
frequency in the banking sector, the network of the financial market infrastructures or the regulatory environment.

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