Financial Network and Interconnected Risk in an Advanced Emerging Economy
Best Paper Award (Best Applied Paper) at 4th European Conference on Banking and the Economy (ECOBATE 2016), Winchester, UK
Conference paper of 2nd RiskLab/BoF/ECB/ESRB Conference on Systemic Risk Analysis in Helsinki, Finland, Oct 2016
40 Pages Posted: 8 Jan 2017 Last revised: 18 Jan 2017
Date Written: January 8, 2017
Abstract
Financial networks could become fragile during periods of economic and financial distress, since interconnectedness among participating firms could transmit and amplify adverse shocks. Relying on balance sheet data, complemented with complete bilateral interbank exposures, this paper analyzes interconnectedness in an advanced emerging market economy, using two complementary approaches. The first (micro) approach focuses on network topology, and finds that this financial system resembles a highly clustered small-world network, with connectivity and exposures exhibiting a (double) heavy tail distribution, which favors the formation of strong community structure and preferential attachment in the network. This shows evidence of convergence to developed economy, Austrian network (Boss et al. (2004)), and another emerging economy, Brazilian network (Cont et al (2012)). Bank size is pareto distributed, and highly correlated with centrality, representing node importance as systemically important financial institutions (SIFIs) in this network. The second (macro) approach focuses on how the network topology contributes to the transmission of shocks modeling default contagion, using balance-sheet network analysis. It finds that direct counterparty credit exposure poses less risk to the banking system than fire-sale losses triggered by liquidity shocks. Both approaches, either using a topological or induced system losses perspective, identify SIFIs consistently by accounting for both macro and microprudential risk dimensions.
Keywords: banking system; emerging market; contagion; systemic risk; interconnectedness; interbank network; centrality; macroprudential; microprudential
JEL Classification: B26; E58; G01
Suggested Citation: Suggested Citation