IDEAS home Printed from https://ideas.repec.org/p/bca/bocawp/19-44.html
   My bibliography  Save this paper

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
    as

    Download full text from publisher

    File URL: https://www.bankofcanada.ca/wp-content/uploads/2019/11/swp2019-44.pdf
    File Function: Full text
    Download Restriction: no
    ---><---

    Other versions of this item:

    References listed on IDEAS

    as
    1. Marco Bardoscia & Stefano Battiston & Fabio Caccioli & Guido Caldarelli, 2016. "Pathways towards instability in financial networks," Papers 1602.05883, arXiv.org, revised Feb 2017.
    2. Marco Bardoscia & Stefano Battiston & Fabio Caccioli & Guido Caldarelli, 2015. "DebtRank: A Microscopic Foundation for Shock Propagation," PLOS ONE, Public Library of Science, vol. 10(6), pages 1-13, June.
    3. Portes, Richard & , & D'Errico, Marco & Killeen, Neill & Luz, Vera & Peltonen, Tuomas & Urbano, Teresa, 2017. "Mapping the interconnectedness between EU banks and shadow banking entities," CEPR Discussion Papers 11919, C.E.P.R. Discussion Papers.
    4. Bardoscia, Marco & Barucca, Paolo & Codd, Adam Brinley & Hill, John, 2019. "Forward-looking solvency contagion," Journal of Economic Dynamics and Control, Elsevier, vol. 108(C).
    5. Roncoroni, Alan & Battiston, Stefano & Escobar-Farfán, Luis O.L. & Martinez-Jaramillo, Serafin, 2021. "Climate risk and financial stability in the network of banks and investment funds," Journal of Financial Stability, Elsevier, vol. 54(C).
    6. Hałaj, Grzegorz, 2018. "System-wide implications of funding risk," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 503(C), pages 1151-1181.
    7. Caccioli, Fabio & Shrestha, Munik & Moore, Cristopher & Farmer, J. Doyne, 2014. "Stability analysis of financial contagion due to overlapping portfolios," Journal of Banking & Finance, Elsevier, vol. 46(C), pages 233-245.
    8. Daron Acemoglu & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2015. "Systemic Risk and Stability in Financial Networks," American Economic Review, American Economic Association, vol. 105(2), pages 564-608, February.
    9. Paolo Barucca & Marco Bardoscia & Fabio Caccioli & Marco D'Errico & Gabriele Visentin & Guido Caldarelli & Stefano Battiston, 2016. "Network Valuation in Financial Systems," Papers 1606.05164, arXiv.org, revised Jun 2020.
    10. Grzegorz Hałaj & Christoffer Kok, 2013. "Assessing interbank contagion using simulated networks," Computational Management Science, Springer, vol. 10(2), pages 157-186, June.
    11. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    12. Battiston, Stefano & Delli Gatti, Domenico & Gallegati, Mauro & Greenwald, Bruce & Stiglitz, Joseph E., 2012. "Liaisons dangereuses: Increasing connectivity, risk sharing, and systemic risk," Journal of Economic Dynamics and Control, Elsevier, vol. 36(8), pages 1121-1141.
    13. Fernando Duarte & Thomas M. Eisenbach, 2021. "Fire‐Sale Spillovers and Systemic Risk," Journal of Finance, American Finance Association, vol. 76(3), pages 1251-1294, June.
    14. Rama Cont & Amal Moussa & Edson B Santos, 2013. "Network structure and systemic risk in banking systems," Post-Print hal-00912018, HAL.
    15. Rama Cont & Lakshithe Wagalath, 2012. "Fire Sales Forensics: Measuring Endogenous Risk," Working Papers hal-00697224, HAL.
    16. Joseph E Stiglitz, 2018. "Where modern macroeconomics went wrong," Oxford Review of Economic Policy, Oxford University Press and Oxford Review of Economic Policy Limited, vol. 34(1-2), pages 70-106.
    17. Wolf Wagner, 2011. "Systemic Liquidation Risk and the Diversity–Diversification Trade‐Off," Journal of Finance, American Finance Association, vol. 66(4), pages 1141-1175, August.
    18. Cont, Rama & Schaanning, Eric, 2019. "Monitoring indirect contagion," Journal of Banking & Finance, Elsevier, vol. 104(C), pages 85-102.
    19. Battiston Stefano & Caldarelli Guido & D’Errico Marco & Gurciullo Stefano, 2016. "Leveraging the network: A stress-test framework based on DebtRank," Statistics & Risk Modeling, De Gruyter, vol. 33(3-4), pages 117-138, December.
    20. Silva, Thiago Christiano & Alexandre, Michel da Silva & Tabak, Benjamin Miranda, 2018. "Bank lending and systemic risk: A financial-real sector network approach with feedback," Journal of Financial Stability, Elsevier, vol. 38(C), pages 98-118.
    21. Gabriele Visentin & Stefano Battiston & Marco D'Errico, 2016. "Rethinking Financial Contagion," Papers 1608.07831, arXiv.org.
    22. Klaus Düllmann & Nancy Masschelein, 2007. "A Tractable Model to Measure Sector Concentration Risk in Credit Portfolios," Journal of Financial Services Research, Springer;Western Finance Association, vol. 32(1), pages 55-79, October.
    23. L. C. G. Rogers & L. A. M. Veraart, 2013. "Failure and Rescue in an Interbank Network," Management Science, INFORMS, vol. 59(4), pages 882-898, April.
    24. Laurent Clerc & Alberto Giovannini & Sam Langfield & Tuomas Peltonen & Richard Portes & Martin Scheicher, 2016. "Indirect contagion: the policy problem," ESRB Occasional Paper Series 09, European Systemic Risk Board.
    25. Hałaj, Grzegorz, 2018. "Agent-based model of system-wide implications of funding risk," Working Paper Series 2121, European Central Bank.
    26. Rodrigo Cifuentes & Hyun Song Shin & Gianluigi Ferrucci, 2005. "Liquidity Risk and Contagion," Journal of the European Economic Association, MIT Press, vol. 3(2-3), pages 556-566, 04/05.
    27. Larry Eisenberg & Thomas H. Noe, 2001. "Systemic Risk in Financial Systems," Management Science, INFORMS, vol. 47(2), pages 236-249, February.
    28. Paolo Barucca & Marco Bardoscia & Fabio Caccioli & Marco D'Errico & Gabriele Visentin & Guido Caldarelli & Stefano Battiston, 2020. "Network valuation in financial systems," Mathematical Finance, Wiley Blackwell, vol. 30(4), pages 1181-1204, October.
    29. Gai, Prasanna & Haldane, Andrew & Kapadia, Sujit, 2011. "Complexity, concentration and contagion," Journal of Monetary Economics, Elsevier, vol. 58(5), pages 453-470.
    30. Marco Bardoscia & Stefano Battiston & Fabio Caccioli & Guido Caldarelli, 2017. "Pathways towards instability in financial networks," Nature Communications, Nature, vol. 8(1), pages 1-7, April.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. David Aikman & Daniel Beale & Adam Brinley-Codd & Anne-Caroline Hüser & Giovanni Covi & Caterina Lepore, 2023. "Macro-Prudential Stress Test Models: A Survey," IMF Working Papers 2023/173, International Monetary Fund.
    2. Lorenčič Eva & Festić Mejra, 2021. "The Impact of Seven Macroprudential Policy Instruments on Financial Stability in Six Euro Area Economies," Review of Economic Perspectives, Sciendo, vol. 21(3), pages 259-290, September.
    3. Gourdel, Régis & Sydow, Matthias, 2023. "Non-banks contagion and the uneven mitigation of climate risk," International Review of Financial Analysis, Elsevier, vol. 89(C).
    4. Gourdel, Régis & Sydow, Matthias, 2022. "Non-banks contagion and the uneven mitigation of climate risk," Working Paper Series 2757, European Central Bank.
    5. C'elestin Coquid'e & Jos'e Lages & Dima L. Shepelyansky, 2020. "Crisis contagion in the world trade network," Papers 2002.07100, arXiv.org.
    6. Mikhail Stolbov & Daniil Parfenov, 2023. "Credit risk linkages in the international banking network, 2000–2019," Risk Management, Palgrave Macmillan, vol. 25(3), pages 1-38, September.
    7. 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.
    8. Chen, Jianyu & Zhang, Jianshun, 2023. "Crude oil price shocks, volatility spillovers, and global systemic financial risk transmission mechanisms: Evidence from the stock and foreign exchange markets," Resources Policy, Elsevier, vol. 85(PB).
    9. Carlos León & Javier Miguélez, 2021. "Securities cross-holding in the Colombian financial system: a topological approach," Studies in Economics and Finance, Emerald Group Publishing Limited, vol. 38(4), pages 786-806, February.
    10. Aldasoro, Iñaki & Hüser, Anne-Caroline & Kok, Christoffer, 2022. "Contagion accounting in stress-testing," Journal of Economic Dynamics and Control, Elsevier, vol. 137(C).
    11. Feinstein, Zachary & Hałaj, Grzegorz, 2023. "Interbank asset-liability networks with fire sale management," Journal of Economic Dynamics and Control, Elsevier, vol. 155(C).
    12. Abad, Jorge & D’Errico, Marco & Killeen, Neill & Luz, Vera & Peltonen, Tuomas & Portes, Richard & Urbano, Teresa, 2022. "Mapping exposures of EU banks to the global shadow banking system," Journal of Banking & Finance, Elsevier, vol. 134(C).
    13. Lebastard, Laura, 2022. "Financial exposure and bank mergers: micro and macro evidence from the EU," Working Paper Series 2724, European Central Bank.
    14. Durrani, Agha & Metzler, Julian & Michail, Nektarios & Werner, Johannes Gabriel, 2022. "Bank lending rates and the remuneration for risk: evidence from portfolio and loan level data," Working Paper Series 2753, European Central Bank.
    15. Curcio, Domenico & Gianfrancesco, Igor & Vioto, Davide, 2023. "Climate change and financial systemic risk: Evidence from US banks and insurers," Journal of Financial Stability, Elsevier, vol. 66(C).
    16. 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.
    17. Feinstein, Zachary & Hałaj, Grzegorz, 2023. "Interbank asset-liability networks with fire sale management," Working Paper Series 2806, European Central Bank.

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Valentina Macchiati & Giuseppe Brandi & Tiziana Di Matteo & Daniela Paolotti & Guido Caldarelli & Giulio Cimini, 2022. "Systemic liquidity contagion in the European interbank market," Journal of Economic Interaction and Coordination, Springer;Society for Economic Science with Heterogeneous Interacting Agents, vol. 17(2), pages 443-474, April.
    2. Marco Bardoscia & Paolo Barucca & Stefano Battiston & Fabio Caccioli & Giulio Cimini & Diego Garlaschelli & Fabio Saracco & Tiziano Squartini & Guido Caldarelli, 2021. "The Physics of Financial Networks," Papers 2103.05623, arXiv.org.
    3. Bardoscia, Marco & Barucca, Paolo & Codd, Adam Brinley & Hill, John, 2019. "Forward-looking solvency contagion," Journal of Economic Dynamics and Control, Elsevier, vol. 108(C).
    4. Wiersema, Garbrand & Kleinnijenhuis, Alissa M. & Wetzer, Thom & Farmer, J. Doyne, 2023. "Scenario-free analysis of financial stability with interacting contagion channels," Journal of Banking & Finance, Elsevier, vol. 146(C).
    5. Fabio Caccioli & Paolo Barucca & Teruyoshi Kobayashi, 2018. "Network models of financial systemic risk: a review," Journal of Computational Social Science, Springer, vol. 1(1), pages 81-114, January.
    6. Tiziano Squartini & Guido Caldarelli & Giulio Cimini & Andrea Gabrielli & Diego Garlaschelli, 2018. "Reconstruction methods for networks: the case of economic and financial systems," Papers 1806.06941, arXiv.org.
    7. Bardoscia, Marco & Ka-Kay Pang, Raymond, 2023. "Ring-fencing in financial networks," Bank of England working papers 1046, Bank of England.
    8. Roncoroni, Alan & Battiston, Stefano & Escobar-Farfán, Luis O.L. & Martinez-Jaramillo, Serafin, 2021. "Climate risk and financial stability in the network of banks and investment funds," Journal of Financial Stability, Elsevier, vol. 54(C).
    9. Barnett, William A. & Wang, Xue & Xu, Hai-Chuan & Zhou, Wei-Xing, 2022. "Hierarchical contagions in the interdependent financial network," Journal of Financial Stability, Elsevier, vol. 61(C).
    10. Paolo Barucca & Marco Bardoscia & Fabio Caccioli & Marco D'Errico & Gabriele Visentin & Guido Caldarelli & Stefano Battiston, 2020. "Network valuation in financial systems," Mathematical Finance, Wiley Blackwell, vol. 30(4), pages 1181-1204, October.
    11. Giulia Poce & Giulio Cimini & Andrea Gabrielli & Andrea Zaccaria & Giuditta Baldacci & Marco Polito & Mariangela Rizzo & Silvia Sabatini, 2016. "What do central counterparties default funds really cover? A network-based stress test answer," Papers 1611.03782, arXiv.org.
    12. Calimani, Susanna & Hałaj, Grzegorz & Żochowski, Dawid, 2022. "Simulating fire sales in a system of banks and asset managers," Journal of Banking & Finance, Elsevier, vol. 138(C).
    13. Spiros Bougheas & Adam Hal Spencer, 2022. "Fire sales and ex ante valuation of systemic risk: A financial equilibrium networks approach," Discussion Papers 2022/04, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
    14. Aikman, David & Beale, Daniel & Brinley-Codd, Adam & Covi, Giovanni & Hüser, Anne‑Caroline & Lepore, Caterina, 2023. "Macroprudential stress‑test models: a survey," Bank of England working papers 1037, Bank of England.
    15. Paul Glasserman & Peyton Young, 2015. "Contagion in Financial Networks," Economics Series Working Papers 764, University of Oxford, Department of Economics.
    16. Covi, Giovanni & Gorpe, Mehmet Ziya & Kok, Christoffer, 2021. "CoMap: Mapping Contagion in the Euro Area Banking Sector," Journal of Financial Stability, Elsevier, vol. 53(C).
    17. Paul Glasserman & H. Peyton Young, 2015. "Contagion in Financial Markets," Working Papers 15-21, Office of Financial Research, US Department of the Treasury.
    18. Sadamori Kojaku & Giulio Cimini & Guido Caldarelli & Naoki Masuda, 2018. "Structural changes in the interbank market across the financial crisis from multiple core-periphery analysis," Papers 1802.05139, arXiv.org.
    19. Bardoscia, Marco & Barucca, Paolo & Brinley Codd, Adam & Hill, John, 2017. "The decline of solvency contagion risk," Bank of England working papers 662, Bank of England.
    20. X. Zhang & L. D. Valdez & H. E. Stanley & L. A. Braunstein, 2019. "Modeling Risk Contagion in the Venture Capital Market: A Multilayer Network Approach," Complexity, Hindawi, vol. 2019, pages 1-11, December.

    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

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:bca:bocawp:19-44. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: the person in charge (email available below). General contact details of provider: https://edirc.repec.org/data/bocgvca.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.