Counterparty Choice, Bank Interconnectedness, and Bank Risk-taking

Andrew Ellul () and Dasol Kim ()
Additional contact information
Andrew Ellul: Indiana University, Office of Financial Research, Centre for Economic Policy Research, Center for Studies of
Dasol Kim: Office of Financial Research

No 22-06, Working Papers from Office of Financial Research, US Department of the Treasury

Abstract: We provide evidence on how banks form network connections and endogenous risk-taking in their non-bank counterparty choices in the OTC derivatives markets. We use confidential regulatory data from the Capital Assessment and Stress Testing reports that provide counterparty-level data across a wide range of OTC markets for the most systemically important U.S. banks. We show that banks are more likely toeither establish or maintain a relationship, and increase their exposures within an existing relationship, with non-bank counterparties that are already heavily connected and exposed to other banks. Banks in such densely-connected networks are more likely to connect with riskier counterparties for their most material exposures. The effects are strongest in the case of (non-bank) financial counterparties. These findings suggest moral hazard behavior in counterparty choices. Finally, we demonstrate that these exposures are strongly linked to systemic risk. Overall, the results suggest a network formation process that amplifies risk propagation through non-bank linkages in opaque financial markets.

Keywords: counterparty risk; financial networks; bank interconnectedness; over-the-counter markets; derivatives (search for similar items in EconPapers)
Pages: 77 pages
Date: 2022-09-22
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
https://www.financialresearch.gov/working-papers/f ... bank-risk-taking.pdf (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:ofr:wpaper:22-06

Access Statistics for this paper

More papers in Working Papers from Office of Financial Research, US Department of the Treasury Contact information at EDIRC.
Bibliographic data for series maintained by Corey Garriott ().