Assessing interbank contagion using simulated networks
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Assessing interbank contagion using simulated networks Grzegorz Hałaj · Christoffer Kok
Received: 12 July 2012 / Accepted: 6 March 2013 / Published online: 4 April 2013 © Springer-Verlag Berlin Heidelberg 2013
Abstract This paper presents a new approach to randomly generate interbank networks while overcoming shortcomings in the availability of bank-by-bank bilateral exposures. Our model can be used to simulate and assess interbank contagion effects on banking sector soundness and resilience. We find a strongly non-linear pattern across the distribution of simulated networks, whereby only for a small percentage of networks the impact of interbank contagion will substantially reduce average solvency of the system. In the vast majority of the simulated networks the system-wide contagion effects are largely negligible. The approach furthermore enables to form a view about the most systemic banks in the system in terms of the banks whose failure would have the most detrimental contagion effects on the system as a whole. Finally, as the simulation of the network structures is computationally very costly, we also propose a simplified measure—a so-called Systemic Probability Index—that also captures the likelihood of contagion from the failure of a given bank to honour its interbank payment obligations but at the same time is less costly to compute. We find that the SPI is broadly consistent with the results from the simulated network structures. Keywords Network theory · Interbank contagion · Systemic risk · Banking · Stress-testing
The views expressed in the paper are those of the authors and do not necessarily reflect those of the ECB. G. Hałaj (B)· C. Kok European Central Bank, Kaiserstrasse 29, 60311 Frankfurt am Main, Germany e-mail: [email protected] C. Kok e-mail: [email protected]
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1 Introduction The inception of the euro created a large and integrated euro area money market, allowing euro area banks to lend and fund themselves via other euro area banks; also across national borders. This helped ease financial transactions and facilitate trade among euro area countries. This success notwithstanding, the global financial crisis erupting in mid-2007 led to heavy losses at many financial institutions and to severe disruptions in the interbank markets as individual institutions lost confidence in the soundness of their peers. This was reinforced by a string of bank failures in the ensuing years, the most prominent being the one of Lehman Brothers (the US investment bank) in September 2008. More recently, the euro area sovereign debt crisis was also accompanied by a number of bank failures and bailouts and raised substantial concerns about the risk of pernicious contagion effects among euro area banks (and their sovereigns). These events have highlighted the systemic risks to the financial system of individual bank failures via the interlinkages that exist between banks; especially in the unsecured interbank market. Particular attention has been paid to potential counterparty r
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