The Interaction between Profitability and Macroeconomic Factors for Future Examinations of European Banks Soundness – Theoretical Study

Any weakness in the financial institution is subject to the contagion mechanism. As result, the whole financial system will experience unpredictable financial risks and possible crisis, such as to a systemically relevant institution (e.g. Lehman Brothers' default, 2008's financial crises and Asian financial crises). The contagion mechanism (Quagliariello, M., 2009 [1] (Trapanese, M.) is a crucial element in the assessment of the cross-border dimension. The direct cross-border contagion risks (idiosyncratic risks) are: risks related to cross-border interbank links; money markets and cross-border ownership links; common shocks of foreign economies and global financial markets that can affect banks' exposures due to changes in credit quality, market valuations and funding costs. Secondly, the indirect cross-border contagion risks (Indirect contagion) are caused by systematics risks that exclusively related to cross-border credit exposures (e.g. lending to non- financial institutions, credit risk transfer exposures as well as international syndicated lending), market risk exposures (by holdings of securities and off-balance sheet positions), common cross-border funding (by financing through market instruments and operational risk). From a theoretical point of view, said institutions are defined as risky banks, have unpredictable impacts on the smoothness of whole financial system. Moreover, these credit, market and liquidity risks represent the main triggers of crises. This paper is the second part of my theoretical study focused on the profitability and the soundness of European banks with an emphasis on the role of the Macro profile. In this paper, I also thoroughly investigated the macroeconomic determinants used to predict the Banking crises. Moreover, this paper analyzed the history and behavior of European banks during financial crises, and the corrective measures taken by authorities, governments and supervisory institutes to bail out the troubled banks, or to support the banking system as a whole. An extensive assessment of collected data resulted in detailed analysis of quantitative methodologies as well as the examination of the effectiveness of selected macroeconomic determinants to avoid the financial instability. This study shows that the macroeconomic adjustments were called upon during the crises.