IMF published a working paper that presents a novel approach to investigate and model the network of euro area banks’ large exposures within the global banking system. Drawing on a unique dataset, the paper documents the degree of interconnectedness and systemic risk of the euro area banking system based on bilateral linkages. The authors of the paper have developed a Contagion Mapping model fully calibrated with bank-level data to study the contagion potential of an exogenous shock via credit and funding risks.
Overall, this paper aims to overcome certain data and modeling gaps in the interconnectedness literature by studying the degree of contagion and vulnerability of euro area significant institutions within the global banking system. The paper presents the data infrastructure and details the topology of euro area interbank network of large exposures. The comprehensive data infrastructure allows to build a detailed modeling framework capturing the specificities of prudential regulations such as minimum capital requirements, macro-prudential capital buffers, the liquidity coverage ratio, and large exposure limits and their interplay with credit, funding, and fire-sale risks. The paper discusses the results based on the contagion and vulnerability score, and provides a multitude of sensitivity tests to determine non-linearities and to check robustness of the results. The paper shows how a range of macro-prudential tools can be fine-tuned to reduce contagion and derives policy implications.
This euro-centric systemic risk assessment highlights that the degree of bank-specific contagion and vulnerability depend on network specific tipping points directly affecting the magnitude of amplification effects. This leads to the conclusion that the identification of such tipping points and their determinants is the essence of an effective micro- and macro-prudential supervision. In this paper, it is argued that, in isolation, variations in bank-specific characteristics seem to play a lesser role than the network structure in changing the degree of amplification effects (non-linearities). Large and uneven shifts across banks in contagion and vulnerability indicators observed when changes in bank-specific characteristics are combined with changes in network structure point to the importance of non-linearities arising from their interactions and their heterogenous impact on banks. In a variety of tests, heterogeneity in the magnitude of bilateral exposures and of bank-specific parameters is detected as a key driver of the total number of defaults in the system.
The results are network and model dependent based on an incomplete set of bilateral exposures. Therefore, both dimensions need to be extended to include additional channels of contagion and in turn improve the loss estimates of an extreme event. Work should be done to incorporate euro area less significant institutions to complete the euro area banking system, to incorporate financial corporations to model the complex interactions within the financial system, and to incorporate exposures to the real economy to capture feedback loops. It is also important to investigate the role of additional prudential requirements that are currently missing in the framework, such as binding leverage and net stable funding ratio, and are being implemented according to the internationally agreed Basel standards. Finally, given the significance of network structure in determining contagion risks, it would be important to study how the network structure changes, over time and in response to systemic shocks, as well as how different network structures impact model results.
Related Link: Working Paper
Keywords: International, Europe, EU, Banking, Large Exposures, Systemic Risk, Macro-Prudential Policy, Stress Testing, Network Analysis, Data, Contagion Mapping, Research, IMF
Previous ArticleEBA Single Rulebook Q&A: Second Update for May 2019
APRA updated the lists of the Direct to APRA (D2A) validation and derivation rules for authorized deposit-taking institutions, insurers, and superannuation entities.
EC adopted a package that includes the digital finance and retail payments strategies and the legislative proposals for regulatory frameworks on crypto-assets and digital operational resilience.
ECB published an opinion (CON/2020/22) on proposals for regulations amending the securitization framework of EU, in response to the COVID-19 pandemic.
FCA is consulting on its approach to the authorization and supervision of international firms operating in UK.
MAS published amendments to Notice 637 on the risk-based capital adequacy requirements for reporting banks incorporated in Singapore.
FCA announced that it will move firms to RegData from Gabriel in the coming months in stages, based on the reporting requirements of firms.
ISDA issued a letter to regulators to flag that it now expects the supplement to the 2006 ISDA Definitions and the Interbank Offered Rate (IBOR) Fallbacks Protocol to be effective around mid- to late-January 2021.
APRA has concluded its review of the comprehensive plans of authorized deposit-taking institutions for the assessment and management of loans with repayment deferrals.
ESAs (EBA, EIOPA, and ESMA) published the first joint report that assesses risks in the financial sector since the outbreak of the COVID-19 pandemic.
BoE and HM Treasury confirmed that the COVID Corporate Financing Facility (CCFF) will close for new purchases of commercial paper, with effect from March 23, 2021.