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The decline of solvency contagion risk

Author

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  • Bardoscia, Marco

    () (Bank of England)

  • Barucca, Paolo

    () (University of Zurich, London Institute for Mathematical Science, IMT Lucca)

  • Brinley Codd, Adam

    () (Bank of England)

  • Hill, John

    () (Bank of England)

Abstract

We study solvency contagion risk in the UK banking system from 2008 to 2015. We develop a model that not only accounts for losses transmitted after banks default, but also for losses due to the fact that creditors revalue their exposures when probabilities of default of their counterparties change. We apply our model to a unique data set of real UK interbank exposures. We show that risks due to solvency contagion decrease markedly from the peak of the crisis to the present, to the point of becoming negligible. By decomposing the change in losses into two main contributions — the increase in banks’ capital and the decrease in interbank exposures — we are able to pinpoint the main driver in each year. In some cases we observe that an increase in aggregate capital is associated with a positive contribution to losses. This suggests that the distribution of capital among banks is also important.

Suggested Citation

  • 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.
  • Handle: RePEc:boe:boeewp:0662
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    References listed on IDEAS

    as
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    Cited by:

    1. Zachary Feinstein & Weijie Pang & Birgit Rudloff & Eric Schaanning & Stephan Sturm & Mackenzie Wildman, 2017. "Sensitivity of the Eisenberg-Noe clearing vector to individual interbank liabilities," Papers 1708.01561, arXiv.org, revised Feb 2018.

    More about this item

    Keywords

    Financial networks; systemic risk; financial contagion; macroprudential policy; stress testing;

    JEL classification:

    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • G01 - Financial Economics - - General - - - Financial Crises
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G38 - Financial Economics - - Corporate Finance and Governance - - - Government Policy and Regulation

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