Capital and Contagion in Financial Networks

Giovanni di Iasio (), Stefano Battiston, Luigi Infante and Federico Pierobon

MPRA Paper from University Library of Munich, Germany

Abstract: We implement a novel method to detect systemically important financial institutions in a network. The method consists in a simple model of distress and losses redistribution derived from the interaction of banks' balance-sheets through bilateral exposures. The algorithm goes beyond the traditional default-cascade mechanism, according to which contagion propagates only through banks that actually default. We argue that even in the absence of other defaults, distressed-but-non-defaulting institutions transmit the contagion through channels other than solvency: weakness in their balance sheet reduces the value of their liabilities, thereby negatively affecting their interbank lenders even before a credit event occurs. In this paper, we apply the methodology to a unique dataset covering bilateral exposures among all Italian banks in the period 2008-2012. We find that the systemic impact of individual banks has decreased over time since 2008. The result can be traced back to decreasing volumes in the interbank market and to an intense recapitalization process. We show that the marginal effect of a bank's capital on its contribution to systemic risk in the network is considerably larger when interconnectedness is high (good times): this finding supports the regulatory work on counter-cyclical (macroprudential) capital buffers.

Keywords: Systemic risk; interbank market; contagion; network; feedback centrality. (search for similar items in EconPapers)
JEL-codes: C45 D85 G01 G21 (search for similar items in EconPapers)
Date: 2013-12
New Economics Papers: this item is included in nep-ban, nep-net and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (16)

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Chapter: Capital and contagion in financial networks (2015)
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