Interconnected bank networks: Shock amplifiers or absorbers in the financial system?

We develop a novel measure of bank interconnectedness, based on their co-lending activities in the syndicated loan market, to examine how a bank’s interconnectedness affects the risk of other banks and systemic market risk. Using syndicated loan data from the top 100 U.S. banks from 1995 to 2011, our empirical analysis shows that higher levels of interconnectedness among banks increase individual bank risk and elevate systemic risk, especially during the global financial crisis. This effect is not observed under normal economic conditions. Additionally, by using Lehman Brothers’ bankruptcy as a natural experiment, we find that banks connected to Lehman contribute significantly more to systemic risk than those not connected. This evidence supports causality rather than mere correlation. • Develop a novel measure of interconnectedness using syndicated loan data. • More extensive connections between two banks increase the risk for both. • Use Lehman Brothers’ bankruptcy as an exogenous shock to uncover the causality from bank intercon- nectedness to systemic risk. • Following Lehman Brothers’ bankruptcy, Lehman-connected banks contributed more to systemic risk than other similar banks.