We construct a measure of systemic vulnerability in selected EU banking systems using an indirect, time-varying measure of the system covariance. Systemic vulnerability indicates the extent to which a banking system as a whole is sensitive to a negative shock. We proceed to examine to what extent the resulting measures of systemic vulnerability provide a convincing narrative of events during the period January 2000 to April 2016. The results provide evidence of: (i) rising vulnerability prior to the outbreak of the international financial crisis in 2007/08 in countries with banks exposed to toxic assets; (ii) vulnerability associated with the euro area sovereign debt crisis from 2009/10; and (iii) continued concerns from 2013 onwards regarding the need for euro area banks to improve their balance sheets and raise new capital at a time of sluggish profitability.

We quantify the linkages among banks’ equity performance and indicators of sovereign stress by using panel GMM to estimate a three-equation system that examines the impact of sovereign stress, as reflected in both sovereign spreads and sovereign ratings, on bank share prices. We use data for a panel of five euro-area stressed countries. Our findings indicate that a recursive relationship between sovereigns and banks operated during the euro-area crisis. Specifically, for the five crisis countries considered shocks to sovereign spreads fed-through to sovereign ratings, which affected commercial banks’ equity-prices. Our results also point to the importance of using levels of equity prices – rather than rates of return – in measuring banks’ performance. The use of levels allows us to derive the determinants of long-run equity prices.

We examine (1) spillover effects between euro-area sovereigns and banking systems within national jurisdictions and (2) cross-country spillovers among ten countries during the euro-area crisis. We find that cross-country spillovers substantially amplify the doom loops between the sovereign and banking sectors. We also provide a test that supports the hypothesis that cross-country spillovers among southern-euro-area countries were of a different order from the spillovers among northern-euro-area countries. Our results also imply that, if shocks are idiosyncratic, spillover effects may help in reducing the impact for northern countries.