Banking on Immunity : EU Macroprudential Policy and Systemic Risk

ABSTRACT Banks get sick too – often with devastating consequences for the health of the wider economy. The European Union (EU) and its Member States are eager to boost the banking sector's resilience to systemic crises and reduce the build-up of systemic risk. This paper investigates the effectiveness of macroprudential policy in containing the systemic risk of 166 European banks across 20 EU Member States between 1995 and 2014 by employing financial institution-level measures of systemic risk, namely the Delta-CoVaR (∆CoVaR) methodology and a comprehensive database of enacted EU macroprudential policies (MaPPED), collected by experts at the ECB in collaboration with Member States' national competent authorities. Using a dynamic panel framework at a quarterly frequency, the findings of this paper suggest that the coming into force of macroprudential policies increase a bank's resilience to system-wide financial distress. However, the evidence also suggests that these policies are not associated with reducing a bank's systemic risk contribution to the EU financial sector, which raises concerns that EU macroprudential policy may not fully boost the financial system's resilience. Specifically, results document that loan loss and lending standard provisions (often denoted in the literature as borrower-based measures) lessen a bank's systemic risk contribution while capital requirements and liquidity provisions appear to increase banks' systemic risk contribution. In addition, sectoral risk weights are associated with increasing the resilience of banks to financial shocks. Results have implications for the continued work of policymakers on the design and calibrations of prudential policy across the EU