Internationalization, Foreign Complexity and Systemic Risk: European Banks Perspective

Using a novel cross-European dataset on bank internationalization, the paper accounts for both organizational and geographic complexity and evaluates its impact on systemic risk and how both the 2008–09 global financial crisis and the 2010–11 European sovereign debt crisis might have modified such an impact. Ahead of the crisis (2005–07), results suggest that bank complexity materially reduces systemic risk and enhances stability, as it encourages banks to take on more diversified risks. While such a relation is inverted during the crisis (2008–11) and after the crisis (2012–13), consistent with the view that, during distress times, international banks have less ability to monitor cross-border risks. Furthermore, we document that complexity affects systemic risk via its impact on bank size, activity diversity and foreign expansion strategies. Regardless of the period, the effect of complexity on systemic risk is accentuated for complex ‘too-big-too-fail’ and banks with strong activity diversity. Conversely, we find that complex banks with merger-acquisition experience and with foreign branching strategy effectively mitigate systemic risk at the acute crisis and the later stage of the crisis, respectively. Findings bear critical policy implications for the implementation of ring-fencing requirements and systemic risk-based capital surcharges.