External Linkages and Contagion Risk in Irish Banks

The large and growing international linkages of big Irish banks expose them to idiosyncratic shocks arising in other countries. We analyze international interdependencies of Irish banks-during both normal times and in periods of large shocks or extreme events-using an existing methodology with distance to default (DD) data constructed from the banks'' equity prices. The data covers daily observations from January 1994 to November 2005. We first construct rolling correlations between DDs of Irish banks and those of banks from other European countries and the U.S. to analyze trends in cross-country interdependencies. We then use a multinomial logit model to estimate the number of banks in Ireland that experience a large shock on the same day as banks in other countries ("coexceedances"), controlling for Ireland-specific and global factors. We find evidence of increasing cross-border interdependencies over time; differing interlinkage patterns in the pre-Euro, post-Euro, and the post-September 11th periods; and significant cross-border contagion risk from the United Kingdom, the United States, and the Netherlands. This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate.Banking;Risk management;Economic models;contagion, systemic risk, banking system, interbank market, banking sector, banking assets, bank deposit, banking crises, commercial property, bank equity, asset management, financial risk, financial contagion, bank stock prices, investment banking, banking risks, banking supervisors, bank distress, bank stock, banking risk, bank exposure, bank supervisors, bank vulnerabilities, banking risk management, banking sectors, financial liberalization, banking license, return on assets, bank risk, bank fragility, bank failures, banks ? assets, banking system fragility, regional bank, probability of default

External Linkages and Contagion Risk in Irish Banks

Increasing financial integration makes the assessment of cross-country linkages crucial for effective financial surveillance. This paper estimates contagion risk between large Irish banks and European and U.S. banks during 1994–2005, using distance-to-default measures and the methodology of extreme value theory. Employing an ordered logit model, and controlling for Ireland-specific and global shocks, we find evidence of significant contagion risk coming from the United Kingdom, the United States, and the Netherlands toward Ireland. We also find that patterns of contagion to Irish banks have shifted over time, coming from the United Kingdom in the pre-euro period and from the United States in the post-2001 period.

Authorized for Distribution by Mark Swinburne

The large and growing international linkages of big Irish banks expose them to idiosyncratic shocks arising in other countries. We analyze international interdependencies of Irish banks—during both normal times and in periods of large shocks or extreme events—using an existing methodology with distance to default (DD) data constructed from the banks ’ equity prices. The data covers daily observations from January 1994 to November 2005. We first construct rolling correlations between DDs of Irish banks and those of banks from other European countries and the U.S. to analyze trends in cross-country interdependencies. We then use a multinomial logit model to estimate the number of banks in Ireland that experience a large shock on the same day as banks in other countries (“coexceedances”), controlling for Ireland-specific and global factors. We find evidence of increasing cross-border interdependencies over time; differing interlinkage patterns in the pre-Euro, post-Euro, and the post-September 11 th periods; and significant cross-border contagion risk from the United Kingdom, the United States, and the Netherlands. This Working Paper should not be reported as representing the views of the IMF. The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate