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Interconnected Banks and Systemically Important Exposures

Author

Listed:
  • Alan Roncoroni
  • Stefano Battiston
  • Marco D’Errico
  • Grzegorz Halaj
  • Christoffer Kok

Abstract

How do banks' interconnections in the euro area contribute to the vulnerability of the banking system? We study both the direct interconnections (banks lend to each other) and the indirect interconnections (banks are exposed to similar sectors of the economy). These complex linkages make the banking system more vulnerable to contagion risks. We use a unique supervisory dataset of the European Central Bank with the 26 largest banks in the euro area. Introducing a new measure of indirect interconnections, we assess to what extent banks are significantly exposed to devaluation risk of commonly held assets. We find that for small shocks, banks that operate in multiple countries make the banking system more resilient. But for large shocks, international diversification makes the banking system less resilient. While contagion risk is usually ignored in supervisory stress tests, it can have significant impacts on banks' solvency and should influence how supervisors design regulations. However, we find there is no one-size-fits-all solution: the optimal financial architecture depends on the shocks considered and the international diversification.

Suggested Citation

  • Alan Roncoroni & Stefano Battiston & Marco D’Errico & Grzegorz Halaj & Christoffer Kok, 2019. "Interconnected Banks and Systemically Important Exposures," Staff Working Papers 19-44, Bank of Canada.
  • Handle: RePEc:bca:bocawp:19-44
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    References listed on IDEAS

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    Cited by:

    1. C'elestin Coquid'e & Jos'e Lages & Dima L. Shepelyansky, 2020. "Crisis contagion in the world trade network," Papers 2002.07100, arXiv.org.
    2. Fukker, Gábor & Kok, Christoffer, 2021. "On the optimal control of interbank contagion in the euro area banking system," Working Paper Series 2554, European Central Bank.
    3. Financial Stability Committee, Task Force on cross-border Spillover Effects of macroprudential measures & Kok, Christoffer & Reinhardt, Dennis, 2020. "Cross-border spillover effects of macroprudential policies: a conceptual framework," Occasional Paper Series 242, European Central Bank.

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    More about this item

    Keywords

    Financial stability;

    JEL classification:

    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • G - Financial Economics
    • G1 - Financial Economics - - General Financial Markets
    • G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
    • G2 - Financial Economics - - Financial Institutions and Services
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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