Search

This paper proposes a new way to model and analyze contagion in interbank networks. We use a unique dataset from the Brazilian financial system and include all active financial intermediaries. We show that the contagion chain has a short propagation path. We find that first-round contagion is generated only by banks and that medium-sized banks can generate contagion, which implies that size is not the sole determinant of importance within networks. Most vulnerable financial institutions are not banks. Finally, we compute a lower bound for the financial system expected losses in a 1-year horizon. The results contribute to the development of a financial stability-monitoring toolkit. [ABSTRACT FROM AUTHOR]

This paper develops a network model of a stylized banking system in which banks are connected to one another through interbank claims, which allows us to study the diffusion of default avalanches triggered by an exogenous shock under a number of different assumptions on the degree of interconnectedness, level of capitalization, liquidity buffers, the size of the interbank market and fire-sales. We expand upon the existing literature by comparing two alternative resolution mechanisms: (i) liquidations triggered by either illiquidity or insolvency-related distress implying asset sales and compensation of creditors; and (ii) a bail-in mechanism avoiding bank closure by forcing a recapitalization provided by bank creditors. Our model speaks to how contagion dynamics unravel via illiquidity-driven defaults in the first case and higher-order losses in the latter one. Within this framework, we show how the liquidity risk externality can be resolved, and we put forward a macro-criterion to assess the adequacy of the liquidity ratio introduced with Basel III. [ABSTRACT FROM PUBLISHER]

We propose a new approach to assess systemic financial stability of a banking system using standard tools from modern risk management in combination with a network model of interbank loans. We apply our model to a unique data set of all Austrian banks. We find that correlation in banks' asset portfolios dominates contagion as the main source of systemic risk. Contagion is rare but can nonetheless wipe out a major part of the banking system. Low bankruptcy costs and an efficient crisis resolution policy are crucial to limit the systemwide impact of contagious default events. We compute the "value at risk" for a lender of last resort and find that the funds necessary to prevent contagion are surprisingly small. [ABSTRACT FROM AUTHOR]

The author argues to remove the debt tax advantage through removing corporation tax or levelling the equity and debt tax treatment. Topics mentioned include the agree on excessive leverage as propagating mechanism, the effect of increased debt on high chances of contagion and bankruptcy, and the warning to financial institutions on the high leverage in the non-financial sector.