Optimization of systemic risk: reallocation of assets based on bank networks

Hu Wang and Shouwei Li

Journal of Risk

Abstract: In this paper, we investigate the optimization of systemic risk based on DebtRank by considering two contagion channels: interbank lending and common asset holdings. The optimization of systemic risk is realized through the reallocation of assets in these two networks (interbank lending and common asset holdings), and China’s interbank lending and sector loans data from 2017 is used to verify this scenario. The results show that under bank shock and asset shock, systemic risk can be significantly reduced through the reallocation of assets in these two networks; the density of the optimized network is significantly higher than that of the original network; and the scale of interbank assets of large-scale banks decreases, while the scale of common asset holdings increases in the optimized network. In addition, the results suggest that systemic risk can be lowered by reducing the existence of a high concentration of bank or sector portfolios, and that a low Herfindahl–Hirschman Index (HHI) plays a role in risk-sharing when there is a less high HHI.

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