Addressing Interconnectedness: Concepts and Prudential Tools

Arregui, Nicolás; Norat, Mohamed; Pancorbo, Antonio; Scarlata, Jodi; Holttinen, Eija; Melo, Fabiana; Surti, Jay; Wilson, Christopher; Wehrhahn, Rodolfo; Yanase, Mamoru

doi:10.5089/9781475531855.001

Cited by 22 publications

(16 citation statements)

References 18 publications

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“…In particular, the research in network theory has dedicated a huge effort to develop measures of interconnectedness, related to the detection of the most important player in a network, in order to capture the impact that an institution’s bilateral exposures have on other institutions within the system [3], [4], [5], [6], [7], [8]. …”

Section: Introductionmentioning

confidence: 99%

Discovering SIFIs in Interbank Communities

2016

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This paper proposes a new methodology based on non-negative matrix factorization to detect communities and to identify central nodes in a network as well as within communities. The method is specifically designed for directed weighted networks and, consequently, it has been applied to the interbank network derived from the e-MID interbank market. In an interbank network indeed links are directed, representing flows of funds between lenders and borrowers. Besides distinguishing between Systemically Important Borrowers and Lenders, the technique complements the detection of systemically important banks, revealing the community structure of the network, that proxies the most plausible areas of contagion of institutions’ distress.

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Section: Introductionmentioning

confidence: 99%

Discovering SIFIs in Interbank Communities

2016

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“…The European Central Bank held already in 2009 a workshop on 'Recent advances in modeling systemic risk using network analysis'. 48 The IMF has recently reviewed tools used to identify and measure interconnectedness in the context of prudential policy (Arregui et al, 2013). 49 Here we will briefly touch on the literature on network measures for identifying critical institutions, discuss stress testing using network models and then turn to policy insights for monetary and macroprudential policy.…”

Section: Policy Insights From Interbank Networkmentioning

confidence: 99%

“…50 There is a growing awareness that not only the size of an institution matters, but also its interconnectedness. Network concepts can be very useful to assess both interconnectedness and key banks in the financial system (Arregui et al, 2013). Two measures stand out in this regard.…”

Section: Identifying Critical Institutionsmentioning

confidence: 99%

Too interconnected to fail: a survey of the interbank networks literature

Hüser¹

2015

JNTF

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A network approach to banking is particularly important for assessing financial stability and systemic risk. This approach can be instrumental in capturing the externalities that the risk associated with a single institution may create for the entire system. Indeed, from a financial stability perspective, banks should neither be too-big-to-fail nor too-interconnected-to-fail. A better understanding of network externalities may facilitate the adoption of a macroprudential framework for financial supervision. Network externalities arise when risk-taking behavior of individual institutions affects other institutions and the system as a whole. To guide policy it becomes necessary, in this context, to measure the systemic importance of individual banks, i.e. their capacity to generate contagion in the rest of the system. The analysis of interbank networks can provide this guidance.Against this background we review the literature on interbank networks, which is part of a growing literature on financial networks. The broader financial networks literature is analyzing connections between financial institutions: banks, but also hedge funds, insurance companies, etc. We restrict the survey's focus on the interbank network literature. This survey presents a systematic overview of our current understanding of the structure of interbank networks, of how network characteristics affect contagion in the banking system and of how banks form connections when faced with the possibility of contagion and systemic risk. In particular, we highlight how the theoretical literature on interbank networks offers a coherent way of studying interconnections, contagion processes and systemic risk, while emphasizing at the same time the many challenges that must be addressed before general results on the link between the structure of the interbank network and financial stability can be established.The theoretical literature has generated a number of insights on the effect of the network structure on contagion. A first result is that the number and magnitude of defaults depend on the network topology. There is now substantial research characterizing those structures that tend to propagate default or alternatively that tend to dampen it. An avenue for further research is to have more realistic network structures on which to analyze contagion. Since empirical studies now provide an increasing number of stylized facts on the interbank network topology, research needs to move beyond deriving results on random networks or on overly simplified structures. Furthermore, the fragility of the system depends on the location in the network of the institution that was initially affected. Intuitively, the failure of core banks is more damaging than the failure of a periphery bank. Finally, another main finding is that there is a trade-off between risk sharing via linkages to other banks and contagion risk due to too many linkages. While the existence of the trade-off is not disputed, there is no consensus on whether a complete network dampens or fuels contag...

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“…Despite its apparent advantages, NSFR has been met with skepticism by the industry for various reasons, such as its intrusive nature in traditional bank role in liquidity and maturity transformation, its effect on intensifying bank competition for scarce deposits, the exacerbation of funding towards shadow banking, the destabilizing abstention of banks with large maturity transformation gap from long-term financing and the disproportional effect on emerging and developing countries' economy whose capital markets are undeveloped and its long-term funding relies mostly on banks (Gobat et al, 2014, Hong;2013). Part of the above concerns are fueled by the lack of familiarity with the NSFR since it's a newly introduced micro prudential measure whose calculation is rather complicated and mechanistic, compared to other structural measures of maturity transformation risk.…”

Section: Introductionmentioning

confidence: 99%

“…The NSFR is expected to go into full effect by January 2018 aiming at banks reducing maturity transformation risk by holding more stable and long-term funding sources against less liquid assets ( Arregui et al, 2013). Despite its apparent advantages, NSFR has been met with skepticism by the industry for various reasons, such as its intrusive nature in traditional bank role in liquidity and maturity transformation, its effect on intensifying bank competition for scarce deposits, the exacerbation of funding towards shadow banking, the destabilizing abstention of banks with large maturity transformation gap from long-term financing and the disproportional effect on emerging and developing countries' economy whose capital markets are undeveloped and its long-term funding relies mostly on banks (Gobat et al, 2014, Hong;2013).…”

Section: Introductionmentioning

confidence: 99%