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System-wide implications of funding risk

Grzegorz Halaj ()

Physica A: Statistical Mechanics and its Applications, 2018, vol. 503, issue C, 1151-1181

Abstract: Funding risk has a systemic aspect that is frequently neglected in research and risk management applications. We build a model that focuses on systemic consequences of funding risk and its links with solvency conditions and account for pertinent interactions between market participants in an agent-based modelling fashion. The model is brought to a set of real banking system data of the stress test component of the 2014 Comprehensive Assessment in the EU, covering all the major banking groups in the EU. The potential shock amplification role of asset managers is studied in the theoretical part of the model, with some styled calibration and simulations. We investigate importance of the channels through which the funding shock hitting financial institutions can propagate across the financial system. We find that the drivers of the contagion transmission, related to available liquidity and capital buffers, sensitivities of funding cost to loss absorption capacity and asset prices to fire sales of assets depend on the heterogeneity of the agents in the financial system. Second, liquidity requirements are effective instruments to mitigate contagion risk. Third, the relationship between funding shocks and contagion losses is nonlinear and exhibits cliff effects. Fourth, we find evidence of an active cross-border channel of contagion with losses spreading from one country to another. Finally, behaviours of the agents under adverse funding conditions can influence the structure of the financial market and the topology of the interbank network under stress depends on the stringency of the regulatory requirements.

Keywords: Liquidity; Systemic risk; Agent-based models (search for similar items in EconPapers)
JEL-codes: G11 G21 C61 (search for similar items in EconPapers)
Date: 2018
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DOI: 10.1016/j.physa.2018.08.060

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Physica A: Statistical Mechanics and its Applications is currently edited by K. A. Dawson, J. O. Indekeu, H.E. Stanley and C. Tsallis

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