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Financial networks and default-driven shocks: an application to banking systems. Francisco Hawas (*) Research Assistant Mathematical Modeling Center Universidad de Chile. (*) Joint project with Arturo Cifuentes and Alejandro Jofré. Motivation. Financial crisis (2007-2008)

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financial networks and default driven shocks an application to banking systems

Financial networks and default-driven shocks: an application to banking systems

Francisco Hawas(*)

Research Assistant

Mathematical Modeling CenterUniversidad de Chile

(*) Joint project with Arturo Cifuentes and Alejandro Jofré

motivation
Motivation
  • Financial crisis (2007-2008)
    • Size of banks?
    • Number of banks?
    • Degree of Interconnections?
      • Direct
      • Indirect
  • Regulatory and academic interest on the topic of financial networks
overview
Overview
  • Problems from the financial regulator viewpoint:
    • Liquidity risk
      • Inability to pay, not necessary a balance sheet problem
    • Solvency risk
      • Balance sheet problem
  • This project will focus, initially, on the solvency aspects
    • Liquidity will be left for a second stage
bank s balance sheet
Bank’s Balance sheet

Assets Liabilities

Cash, Ck

Deposits, Dk

Loans to third parties, Lk

Debt to CB, Фk

Loans to other banks, Bk

Debts to other banks, Hk

Deposits at CB, θ Dk

Investments, Ik

Equity, Ek

model overview
Model Overview
  • Define balance sheet parameters:
    • , L, D, I, Ф, H, E, Θ
  • Define interconnection parameters
    • β, ρ
    • Direct connections between banks
      • : percentage of bank’s debt that bank owns
      • ; : number of banks
    • Indirect connections
      • : correlation through loans (L)
slide6

Bank 1

Indirect connection

Loans to third parties

Gaussian Copula [ε, ρ]

Bank N

model overview1
Model Overview
  • At time :
    • Simulate
      • : default loss
      • Gaussian Copula
      • Uniform marginals
    • Update
    • If bank has , then defaults
      • goes out of the simulation
      • Update
      • Loop until
    • Next period
model overview2
Model Overview

End point:

All Banks have defaulted

End of simulation time

Bank k such that will continue in the simulation

example
Example
  • Parameters:
    • : 5%
    • : 30%
    • Θ: 0
    • Equity ratio: 10%
    • All balance sheets are the same
example1
Example
  • Parameters:
    • : 5%
    • : 30%
    • Θ: 0
    • Equity ratio: 8%-12%
    • All balance sheets are similar (Just Equity ratio differs)
topics to investigate
Topics to investigate
  • Influence of balance sheet structure
    • Leverage ratio
  • Central Bank policy
    • Effect of Θ
    • Rescue loan policy
  • Effects of number of banks
    • No diversification effects?
  • Effects of number of connections
    • Selection of counterparty is random
important questions to be answered
Important questions to be answered
  • Does diversification improve system resilience?
  • Is interconnection (degree of) harmful for the financial system?
  • Importance of correlation at a fundamental level… important?
  • Is the dynamics of correlation important?
    • Steady, peak, steady, relevant?
  • What would be the effect of a run on a bank? Or the system? At which speed the system turn into unstable mode?