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 ArticleBrazilian Authorities to Implement Regulatory Sandbox
EBA published an erratum for the technical package on phase 2 of the reporting framework 3.0.
MAS amended Notice 643A that addresses requirements for banks to prepare statements of exposures and credit facilities to related concerns or parties.
ECB has published, in the Official Journal of the European Union, the Guideline 2021/565 on the euro short-term rate (€STR) and this guideline amends the previous ECB Guideline 2019/1265.
EBA launched a consultation on the draft regulatory technical standards on the list of countries with an advanced economy for calculating the equity risk under the alternative standardized approach (FRTB-SA).
PRA is proposing, via CP7/21, the approach to implementing new requirements related to the specification of the nature, severity, and duration of an economic downturn in the internal ratings-based (IRB) approach to credit risk.
The UK government launched the Recovery Loan Scheme (RLS) as part of its continued COVID-19 support for UK businesses, as announced by HM Treasury on March 03, 2021.
FSB published a letter, from its Chair Randal K. Quarles, to the G20 Finance Ministers and Central Bank Governors, ahead of their virtual meeting on April 07, 2021.
OSFI issued a letter to the deposit-taking institutions issuing covered bonds and announced the unwinding of the temporary increase to the covered bond limit for deposit-taking institutions, effective immediately.
To support recovery from the COVID-19 crisis, EU has published two regulations to amend the securitization framework, as set out in the Securitization Regulation (2017/2402) and the Capital Requirements Regulation or CRR (575/2013).
HM Treasury announced that G7 Finance Ministers and Central Bank Governors met ahead of COP 26, the 2021 UN Climate Change Conference, and agreed on green agenda.