Cross‐Border Exposures and Financial Contagion

Integrated financial markets provide opportunities for expansion and improved risk sharing, but also pose threats of contagion risk through cross‐border exposures. This paper examines cross‐border contagion risk over the period 1999–2006. To that purpose we use aggregate cross‐border exposures of 17 countries as reported in the Bank for International Settlements Consolidated Banking Statistics. We find that a shock that affects the liabilities of one country may undermine the stability of the entire financial system. Particularly, a shock wiping out 25% (35%) of US (UK) cross‐border liabilities against non‐US (non‐UK) banks could lead to bank contagion eroding at least 94% (45%) of the recipient countries' banking assets. We also find that since 2006 a shock to Eastern Europe, Turkey and Russia affects most countries. Our simulations also reveal that the ‘speed of propagation of contagion’ has increased in recent years resulting in a higher number of directly exposed banking systems. Finally, we find that contagion is more widespread in geographical proximities.