Syndication increases the overlap of bank loan portfolios and makes them more vulnerable to contagious effects. We develop a novel measure of bank interconnectedness using syndicated corporate loan portfolios, overlap based on industry and region, and different weights such as equal weights, size and relationships. We find that interconnectedness is driven mainly by bank diversification, less by bank size or overall loan market size. Interconnectedness is positively correlated with different bank-level systemic risk measures including SRISK, DIP and CoVaR, and such a positive correlation mainly arises from an elevated effect of interconnectedness on systemic risk during recessions. Overall, our results highlight that institution-level risk reduction through diversification ignores the negative externalities of an interconnected financial system.

European banks are exposed to a substantial amount of risky sovereign debt. “Missing capital” in the banking system resulting from the zero-risk weight exemption for European sovereign debt amplifies the co-movement between sovereign CDS spreads and facilitates cross-border crisis spillovers. Risks spill over from risky peripheral sovereigns to safer core countries, but not in the opposite direction nor for exposures to countries not exempted from risk-weighting. Unfunded non-domestic sovereign bond exposures primarily affect CDS spreads of non-GIIPS banks, while domestic sovereign-to-bank linkages are particularly important for GIIPS banks. Spillovers are attenuated when banks fund their sovereign bond exposures with capital.