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Risk Assessment for Banking Systems

  • Helmut Elsinger

    ()

    (Department of Finance, University of Vienna, BrĂ¼nner Strasse 72, A-1210 Vienna, Austria)

  • Alfred Lehar

    ()

    (Haskayne School of Business, University of Calgary, 2500 University Drive NW, Calgary, Alberta, Canada T2N 1N4)

  • Martin Summer

    ()

    (Economic Studies Division, Oesterreichische Nationalbank, Otto-Wagner-Platz 3, A-1011 Vienna, Austria)

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.

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File URL: http://dx.doi.org/10.1287/mnsc.1060.0531
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Article provided by INFORMS in its journal Management Science.

Volume (Year): 52 (2006)
Issue (Month): 9 (September)
Pages: 1301-1314

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Handle: RePEc:inm:ormnsc:v:52:y:2006:i:9:p:1301-1314
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  1. de Bandt, Olivier & Hartmann, Philipp, 2000. "Systemic Risk: A Survey," CEPR Discussion Papers 2634, C.E.P.R. Discussion Papers.
  2. Hans Degryse & Grégory Nguyen, 2004. "Interbank exposures: an empirical examination of systemic risk in the Belgian banking system," Working Paper Research 43, National Bank of Belgium.
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  4. Giesecke, Kay & Weber, Stefan, 2004. "Cyclical correlations, credit contagion, and portfolio losses," Journal of Banking & Finance, Elsevier, vol. 28(12), pages 3009-3036, December.
  5. Christian Upper & Andreas Worms, 2001. "Estimating bilateral exposures in the German interbank market: is there a danger of contagion?," BIS Papers chapters, in: Bank for International Settlements (ed.), Marrying the macro- and micro-prudential dimensions of financial stability, volume 1, pages 211-229 Bank for International Settlements.
  6. Joshua V. Rosenberg & Til Schuermann, 2004. "A general approach to integrated risk management with skewed, fat-tailed risks," Staff Reports 185, Federal Reserve Bank of New York.
  7. James, Christopher, 1991. " The Losses Realized in Bank Failures," Journal of Finance, American Finance Association, vol. 46(4), pages 1223-42, September.
  8. C. H. Furfine, 1999. "Interbank exposures: quantifying the risk of contagion," BIS Working Papers 70, Bank for International Settlements.
  9. Martin Summer, 2003. "Banking Regulation and Systemic Risk," Open Economies Review, Springer, vol. 14(1), pages 43-70, January.
  10. Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, vol. 47(2), pages 236-249, February.
  11. Furfine, Craig H, 2003. " Interbank Exposures: Quantifying the Risk of Contagion," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(1), pages 111-28, February.
  12. X. Freixas & B. Parigi & J-C. Rochet, 2000. "Systemic Risk, Interbank Relations and Liquidity Provision by theCentral Bank," DNB Staff Reports (discontinued) 47, Netherlands Central Bank.
  13. Glenn Hoggarth & Ricardo Reis & Victoria Saporta, 2001. "Costs of banking system instability: some empirical evidence," Bank of England working papers 144, Bank of England.
  14. M. Davis & V. Lo, 2001. "Infectious defaults," Quantitative Finance, Taylor & Francis Journals, vol. 1(4), pages 382-387.
  15. Crouhy, Michel & Galai, Dan & Mark, Robert, 2000. "A comparative analysis of current credit risk models," Journal of Banking & Finance, Elsevier, vol. 24(1-2), pages 59-117, January.
  16. Jon Frye, 2000. "Depressing recoveries," Emerging Issues, Federal Reserve Bank of Chicago, issue Oct.
  17. Edward I. Altman & Brooks Brady & Andrea Resti & Andrea Sironi, 2005. "The Link between Default and Recovery Rates: Theory, Empirical Evidence, and Implications," The Journal of Business, University of Chicago Press, vol. 78(6), pages 2203-2228, November.
  18. Vanessa Redak & Eleonora Weiss, 2004. "Innovative Credit Risk Transfer Instruments and Financial Stability in Austria," Financial Stability Report, Oesterreichische Nationalbank (Austrian Central Bank), issue 7, pages 64-76.
  19. Franklin Allen & Douglas Gale, 1998. "Financial Contagion Journal of Political Economy," Center for Financial Institutions Working Papers 98-31, Wharton School Center for Financial Institutions, University of Pennsylvania.
  20. Angelini, P. & Maresca, G. & Russo, D., 1996. "Systemic risk in the netting system," Journal of Banking & Finance, Elsevier, vol. 20(5), pages 853-868, June.
  21. George Sheldon & Martin Maurer, 1998. "Interbank Lending and Systemic Risk: An Empirical Analysis for Switzerland," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 134(IV), pages 685-704, December.
  22. Martin Hellwig, 1995. "Systemic Aspects of Risk Management in Banking and Finance," Swiss Journal of Economics and Statistics (SJES), Swiss Society of Economics and Statistics (SSES), vol. 131(IV), pages 723-737, December.
  23. Huberto M. Ennis, 2001. "On the size distribution of banks," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 1-25.
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