The sources of contagion risk in a banking sector with foreign ownership

- We compare the risk of contagion between local banks and their foreign owners.
- The data set covers the Czech Republic, Poland, Slovakia, and Turkey.
- We use a method based on extreme value theory and account for fat-tail shocks.
- The risk of contagion between local banks reaches 10%.
- The risk of contagion between a foreign bank and its local subsidiary is only 5%.

Foreign-dominated banking sectors, such as those prevalent in Central and Eastern Europe, are susceptible to two major sources of systemic risk: (i) linkages between local banks and (ii) linkages between a foreign parent bank and its local subsidiary. During and after the global financial crisis, the second source of risk has been stressed by local regulators. Using a nonparametric method based on extreme value theory, we analyze interdependencies in downward risk in the banking sectors of the Czech Republic, Poland, Slovakia, and Turkey during 1994-2013. We find that the risk of contagion from a foreign parent bank to its local subsidiary is substantially smaller than the risk between two local banks.