Assessing the interconnectedness and systemic risk contagion in the Chinese banking network

Abstract

PurposeIn this paper, the authors use the balance sheet data to investigate the interconnectedness and risk contagion effects in China's banking sector. They firstly study the network structure and centrality of the interbank network. Then, they investigate how and to what extent the credit shock and liquidity shock can lead to the risk propagation in the banking network.Design/methodology/approachReferring to the theoretical framework by Haldane and May (2011), this paper uses the network topology theory to analyze the contagion mechanism of credit shock and liquidity shock. Centrality measures and log-log plot are used to evaluate the interconnectedness of China's banking network.FindingsThe network topology has shown clustering effects of large banks in China's financial network. If the Industrial and Commercial Bank of China (ICBC) is in distress, the credit shock has little impact on the Chinese banking sector. However, the liquidity shock has shown more substantial effects than that of the credit shock. The discount rate and the rollover ratio play significant roles in determining the contagion effects. If the credit shock and liquidity shock coincide, the contagion effects will be amplified.Research limitations/implicationsThe results of this paper reveal the network structure of China's interbank market and the resilience of banking system to the adverse shock. The findings are valuable for regulators to make policies and supervise the systemic important banks.Originality/valueThe balance sheet data of different types of banks are used to construct a bilateral exposure matrix. Based on the matrix, this paper investigates the knock-on effects of credit shock triggered by the debt default in the interbank market, the knock-on effects of liquidity effects, which is featured by “fire sale” of bank assets, and the contagion effects of combined shocks.

Study on liquidity risk of commercial banks

“…Some scholars have also used data on interbank business in banks' balance sheets to conduct empirical analyses. Qi et al (2022) compared and analysed the development characteristics of the interbank business from three aspects: business scale, business structure, and capital flow, and explored the direction of capital flow and potential risks of the interbank business.…”

Systemic risk prevention policies targeting systemically important banks: Does clustering pattern matter?

“…In the increasingly uncertain external environment, there is a great tendency to cluster among homogeneous banks, generating apparent community/cluster structure in interbank networks. Particularly, systemically important banks (SIBs) always have close business connections [ 1 – 3 ]. Taking the Chinese market as an example, large state-owned commercial banks usually tend to establish business ties with banks of the same type (due to factors such as historical business relationships, similar business models, and easy access to liquidity) rather than with other small- and medium-sized banks.…”