Unravelling Systemic Risk Determinants in theEuropean Banking Sector: Is it Just a Matter of Size?

Given the well-established role of banking sector instability in driving financial and economic crises, thispaper investigates the potential determinants of systemic risk on a selected sample of European listed banks.Drawing from a comprehensive review of literature, we employ a novel LASSO (Least Absolute Shrinkageand Selection Operator) enhancement of a panel data regression model to pinpoint the balance-sheet factorsthat significantly explain the systemic risk levels of the banking institutions. The analysis highlights that theinterbank exposures among banks—measured through metrics like the interbank ratio—greatly amplifiessystemic risk, particularly during crises. Distinctively from past literature, this finding underscores theimportance of ’interconnectedness’ over bank size, whit the latter exhibiting a non-linear impact on systemicrisk level. Furthermore, our findings suggest that excessive bank capital can amplify the systemic importanceof institutions by fostering risk-taking behaviour among highly capitalized banks. Methodologically, ourLASSO-based framework enhances variable selection by filtering out statistical noise and mitigatingmulticollinearity issues, thereby isolating the most relevant drivers of systemic risk. From a regulatorystandpoint, our findings advocate for supervisory frameworks that explicitly integrate interbank exposuremetrics into capital regulation and systemic risk assessments, thereby aligning prudential requirements withthe true network-driven nature of systemic risk