Bank contagion

The following will be discussed in this chapter: Lender of last resort, classical theory, LOLR and bank closure policy solvent banks and insolvent banks, systemic risk contagion, liquidity in a non functioning interbank market, LOLR policy as part of the banking safety net.

51p nanhankhuoctai9 23-07-2020 28 3   Download

By analysing the risk of interbank contagion during two distinctive crises, namely the Finnish banking crisis in the 1990s and the most recent financial crisis of the 2000s, this paper provides evidence on negative domino effects in a small open economy with a concentrated banking system. Simulations based on interbank exposures and maximum entropy estimations shed light on the magnitude of the contagion and the vulnerability to cross-border risks.

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This study attempts to quantify the shocks to a banking network and analyze the transfer of shocks through the network. We consider two sources of shocks: external shocks due to market and macroeconomic factors which impact the entire banking system, and idiosyncratic shocks due to failure of a single bank. The external shocks we considered in this study are due to exchange rate shocks. An ARMA/GARCH model is used to extract i.i.d. residuals for this purpose.

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This paper follows Allen and Gale (2000) to model financial contagion as an equilibrium phenomenon. I assume a two-country economy where banks in each country hold interregional claims on other banks to provide insurance against liquidity preference shocks. The results replicate Allen-Gale model.

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Since the swap counterparty is typically the bank also acting as ETF provider, investors may be exposed if the bank defaults 6 . Therefore, problems at those banks that are most active in swap-based ETFs may constitute a powerful source of contagion and systemic risk. In addition, the incentives behind the creation of synthetic ETFs may not be aligned along the ETF chain, especially as conflicts of interest can arise from the dual role of some banks as ETF provider and derivative counterparty7 .

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Here, bank A has borrowed from bank B, and bank B has borrowed from bank C, etc. Then, if A takes a hit and defaults, then bank B will suffer a loss. If the loss is large enough to wipe out B’s capital, then B defaults. Bank C then takes a hit. In turn, if the loss is big enough, bank C defaults, etc. We could dub this the “domino” model of fi nancial contagion. If the domino model of fi nancial contagion is the relevant one for our world, then defaults on subprime mortgages would have had...

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Consider a nancial network in which n nancial intermediaries, `banks' for short, are randomly linked together by their claims on each other. In the language of graph theory, each bank represents a node on the graph and the interbank exposures of bank i dene the links with other banks. These links are directed and weighted, reecting the fact that interbank exposures comprise assets as well as liabilities and that the size of these exposures is important for contagion analysis.

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We also model the contagion process in a relatively mechanical fashion, holding balance sheets and the size and structure of interbank linkages constant as default propagates through the system. Arguably, in normal times in developed nancial systems, banks are sufciently robust that very minor variations in their default probabilities do not affect the decision of whether or not to lend to them in interbank markets.

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The most well-known contribution to the analysis of contagion through direct linkages in nancial systems is that of Allen and Gale (2000). 2 Using a network structure involving four banks, they demonstrate that the spread of contagion depends crucially on the pattern of interconnectedness between banks. When the network is complete, with all banks having exposures to each other such that the amount of interbank deposits held by any bank is evenly spread over all other banks, the impact of a shock is readily attenuated. Every bank takes a small `hit' and there is no contagion.

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Policymaking to deal with the global financial crisis and ensuing global recession has now moved from containing the contagion to specific actions aimed at promoting recovery and changing regulations to prevent a reoccurrence of the problem. Other issues, such as health care and the war in Afghanistan, also are competing for attention. Some have expressed concern that the improving economic and financial outlook may cause regulatory reform of the financial system to lose some traction in the crowded policy agenda.

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For the banking group as a whole, costs of doing business may be lower under the branch structure than under the subsidiary structure. Maintaining greater self- sufficiency of affiliates in a subsidiary structure requires that each affiliate hold higher capital and liquidity buffers to limit the likelihood of failure. This results in higher levels of capital and funding for the banking group as a whole than under the branch structure.

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Regulatory authorities have always been reluctant to grant the permission for entering lending business to savings banks. However, a certain number of (postal) savings banks (e.g.

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Financial market infrastructures (FMIs) that facilitate the clearing, settlement, and recording of monetary and other financial transactions can strengthen the markets they serve and play a critical role in fostering financial stability. However, if not properly managed, they can pose significant risks to the financial system and be a potential source of contagion, particularly in periods of market stress. Although FMIs performed well during the recent financial crisis, events highlighted important lessons for effective risk management.

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It was presently found that a credit for money deposited in the Cham- ber was quite equivalent to so much cash in band; and the custom was introduced of effecting payments by the transfer of these credits from the account of the payer to that of the receiver. In this way the trouble of counting large sums of coin, and of transporting it from one part of the city to another, was wholly avoided. So great were the supposed advan- tages of this method of doing business, that what at first had been vol- untary on the part of the merchants, was afterwards enforced by law. Every merchant...

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Concerns over the 1997/98 Asian financial crisis and its contagion effects further spurred Indian authorities to strengthen the domestic financial system. Reforms were, and continue to be, based on several principles: (i) mitigate risks in the financial system; (ii) efficiently allocate resources to the real sector; (iii) make the financial system competitive globally; and (iv) open the external sector.

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Jurisdictional Uncertainty. This is a vaguely defined term that refers to weaknesses in property rights and contract-enforcing institutions. The term was coined by Arida, Bacha, and Lara-Resende (2004) who describe it as some form of anticreditor bias, the risk of changing the value of contracts before or at the moment of their execution, and the risk of an unfavorable interpretation of contracts in case of a court ruling.

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