The relevance of banks to the European stock market

Banks have always played an ambivalent role in financial markets. On the one hand, they provide essential services for the market; on the other hand, problems in the banking sector can send shock waves through the entire economy. Given this prominent role, it is not surprising that Pereira and Rua [2018. "Asset Pricing with a Bank Risk Factor." Journal of Money, Credit and Banking 50(5): 993-1032. doi:10.1111/jmcb.12473] found that the health of the banking sector exerts an influence on stock returns in the US. Understanding the relationship between banks and their impact on the asset prices of non-financials is essential to evaluate the risk emanating from an unhealthy banking sector and should be considered in new regulatory requirements. The aim of this study is to determine if the health of European banks is of such importance for the European stock market so that spillover effects are visible. Our results show that none of our banking-health variables have explanatory power on the cross-section of European stock returns. These findings contrast those for the US. The reasons may be manifold, from an unimportant liquidity provisioning channel over reduced room for actions due to regulatory requirements up to a moral hazard situation in Europe, where investors strongly rely on the governmental bailouts of distressed banks.