Dynamic Risk in the U.S. Banking System: An Analysis of Sentiment, Policy Shocks, and Spillover Effects

TL;DR

This paper analyzes the 2023 U.S. banking crisis, revealing how perceived similarities among banks and market sentiment amplified systemic risk through a high-frequency contagion channel, emphasizing the need for real-time monitoring.

Contribution

It introduces a novel application of TVP-VAR to capture rapid systemic risk spillovers driven by perceived bank similarities and sentiment during a crisis.

Findings

Systemic connectedness surged during the crisis peak.

SIVB, FRC, and WAL were primary risk transmitters.

Market sentiment and policy uncertainty amplified spillovers.

Abstract

The 2023 U.S. banking crisis propagated not through direct financial linkages but through a high-frequency, information-based contagion channel. This paper moves beyond exploration analysis to test the "too-similar-to-fail" hypothesis, arguing that risk spillovers were driven by perceived similarities in bank business models under acute interest rate pressure. Employing a Time-Varying Parameter Vector Autoregression (TVP-VAR) model with 30-day rolling windows, a method uniquely suited for capturing the rapid network shifts inherent in a panic, we analyze daily stock returns for the four failed institutions and a systematically selected peer group of surviving banks vulnerable to the same risks from March 18, 2022, to March 15, 2023. Our results provide strong evidence for this contagion channel: total system connectedness surged dramatically during the crisis peak, and we identify SIVB, FRC, and WAL as primary net transmitters of risk while their perceived peers became significant net receivers, a key dynamic indicator of systemic vulnerability that cannot be captured by asset-by-asset analysis. We further demonstrate that these spillovers were significantly amplified by market sentiment (as measured by the VIX) and economic policy uncertainty (EPU). By providing a clear conceptual framework and robust empirical validation, our findings confirm the persistence of systemic risks within the banking network and highlight the importance of real-time monitoring in strengthening financial stability.