BIS published a working paper on measuring contagion risk in international banking. In the paper, the authors propose a distress measure for national banking systems to incorporate not only banks’ credit default swap (CDS) spreads, but also how they interact with the rest of the global financial system via multiple linkage types. The measure is based on a tensor decomposition method that extracts an adjacency matrix from a multi-layer network, measured using banks’ foreign exposures obtained from the BIS international banking statistics. Based on this adjacency matrix, the authors develop a new network centrality measure that can be interpreted in terms of the credit risk or funding risk of a banking system.
The rapid growth of the global financial system over the past couple of decades has increased the importance of properly measuring contagion risk. This is true not only from a financial stability point of view, but also from a macroeconomic perspective, as financial crises tend to have significant and persistent negative effects on economic activity. Additionally, the increased interconnectedness and complexity of the global banking system have made that task extremely challenging. A novel methodology for measuring contagion risk in international banking has been proposed in the paper.
The empirical analysis suggests that the measure generated using the novel methodology predicts CDS spreads better than an alternative measure based on (unadjusted) past values of CDS spreads. This is the case, especially during crisis times, when the non-linear network effects tend to be more important. The methodology can be rather useful for policymakers, as it gives an early warning measure of a national banking system’s distress levels, which incorporates information on its foreign exposures. The measure can also be extended to any multi-layer financial network, such as an interbank network. Furthermore, the methodology that has been proposed could potentially be utilized in a bottom-up stress test. More precisely, the proposed methodology could generate estimates of the expected losses of an institution, while incorporating all relevant information on (direct and indirect) exposures, linkages, and contagion probabilities.
Related Link: Working Paper
Keywords: International, Banking, Securities, Contagion Risk, CDS, Credit Risk, Stress Testing, Research, Swaps, BIS
Previous ArticleBaFin Consults on Risk-Bearing Capacity Information Regulation
EC published Regulation 2021/25 that addresses amendments related to the financial reporting consequences of replacement of the existing interest rate benchmarks with alternative reference rates.
BIS published a bulletin, or a note, that examines the cyber threat landscape in the context of the pandemic and discusses policies to reduce risks to financial stability.
HM Treasury, also known as HMT, has updated the table containing the list of the equivalence decisions that came into effect in UK at the end of the transition period of its withdrawal from EU.
EBA published an erratum for technical package on phase 1 of the reporting framework 3.0.
APRA updated a frequently asked question (FAQ), for authorized deposit-taking institutions, on the measurement of credit risk weighted assets.
EBA published the quarterly risk dashboard, along with the results of the Risk Assessment Questionnaire survey among 60 banks and 15 market analysts.
ECB concluded the public consultation on the introduction of a digital euro in EU.
ECB published a guide that sets out the supervisory approach to consolidation in the banking sector.
The SRB Chair Elke König published an article setting out work priorities for 2021.
FDIC has selected 11 technology companies—including BearingPoint, Fed Reporter, Inc, and S&P Global Market Intelligence, LLC—for inclusion in the third and final phase of the rapid prototyping competition.