Diversification, diversity and systemic risk in European banking

At present capital requirements, which aim at ensuring the solvency of individual banks, are the cornerstone of bank regulation. However, such regulation ignores the new form of systemic risk, together with their spillover effects that emerged with the processes of financial globalization and the deregulation of national financial systems. As a result of these processes, large banks' portfolios were more homogeneous than before. Furthermore, the interconnectedness between these institutions and between them and markets has also increased significantly. We provide an empirical analysis to determine the extent to which this process has affected the stability of European banks. We find two conclusions. First, we show that diversity in the portfolio structure of the large European banks has markedly declined since the early 1990s. Second, we show that bank size is proportional to the homogeneity of the structure of financial portfolios. Thus in Europe the systemic risk connected to common shocks has increased significantly, with the result that it has become more necessary to pay added attention to this aspect in bank regulation.