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Shock amplification in an interconnected financial system of banks and investment funds

Author

Listed:
  • Sydow, Matthias
  • Schilte, Aurore
  • Covi, Giovanni
  • Deipenbrock, Marija
  • Del Vecchio, Leonardo
  • Fiedor, Pawel
  • Fukker, Gábor
  • Gehrend, Max
  • Gourdel, Régis
  • Grassi, Alberto
  • Hilberg, Björn
  • Kaijser, Michiel
  • Kaoudis, Georgios
  • Mingarelli, Luca
  • Montagna, Mattia
  • Piquard, Thibaut
  • Salakhova, Dilyara
  • Tente, Natalia

Abstract

This paper shows how the combined endogenous reaction of banks and investment funds to an exogenous shock can amplify or dampen losses to the financial system compared to results from single-sector stress testing models. We build a new model of contagion propagation using a very large and granular data set for the euro area. Based on the economic shock caused by the Covid-19 outbreak, we model three sources of exogenous shocks: a default shock, a market shock and a redemption shock. Our contagion mechanism operates through a dual channel of liquidity and solvency risk. Our analysis reveals that adding the fund sector to our model for banks leads to additional losses through fire sales and a further depletion of banks’ capital ratios by around one percentage point. The main driver of additional bank losses are endogenous market losses generated by investment funds’ asset liquidation.

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  • Sydow, Matthias & Schilte, Aurore & Covi, Giovanni & Deipenbrock, Marija & Del Vecchio, Leonardo & Fiedor, Pawel & Fukker, Gábor & Gehrend, Max & Gourdel, Régis & Grassi, Alberto & Hilberg, Björn & Ka, 2024. "Shock amplification in an interconnected financial system of banks and investment funds," Journal of Financial Stability, Elsevier, vol. 71(C).
    • Handle: RePEc:eee:finsta:v:71:y:2024:i:c:s1572308924000196
    DOI: 10.1016/j.jfs.2024.101234
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    Cited by:

    1. Gourdel, Régis & Sydow, Matthias, 2023. "Non-banks contagion and the uneven mitigation of climate risk," International Review of Financial Analysis, Elsevier, vol. 89(C).
    2. Gourdel, Régis & Sydow, Matthias, 2022. "Non-banks contagion and the uneven mitigation of climate risk," Working Paper Series 2757, European Central Bank.
    3. Aldasoro, Iñaki & Hüser, Anne-Caroline & Kok, Christoffer, 2022. "Contagion accounting in stress-testing," Journal of Economic Dynamics and Control, Elsevier, vol. 137(C).
    4. Giovanni di Iasio & Spyridon Alogoskoufis & Simon Kordel & Dominika Kryczka & Giulio Nicoletti & Nicholas Vause, 2022. "A model of system-wide stress simulation: market-based finance and the Covid-19 event," Questioni di Economia e Finanza (Occasional Papers) 687, Bank of Italy, Economic Research and International Relations Area.
    5. Fukker, Gábor & Kaijser, Michiel & Mingarelli, Luca & Sydow, Matthias, 2022. "Contagion from market price impact: a price-at-risk perspective," Working Paper Series 2692, European Central Bank.
    6. Nicoletti, Giulio & Rariga, Judit & Rodriguez d’Acri, Costanza, 2024. "Spare tyres with a hole: investment funds under stress and credit to firms," Working Paper Series 2917, European Central Bank.
    7. Hasman, Augusto & Samartín, Margarita, 2023. "Government intervention, linkages and financial fragility," Economic Modelling, Elsevier, vol. 126(C).
    8. Sydow, Matthias & Fukker, Gábor & Dubiel-Teleszynski, Tomasz & Franch, Fabio & Gründl, Helmut & Miccio, Debora & Pellegrino, Michela & Gallet, Sébastien & Kotronis, Stelios & Schlütter, Sebastian & So, 2024. "Banks and non-banks stressed: liquidity shocks and the mitigating role of insurance companies," Working Paper Series 3000, European Central Bank.
    9. Martijn Boermans, 2022. "A literature review of securities holdings statistics research and a practitioner’s guide," Working Papers 757, DNB.
    10. Feinstein, Zachary & Hałaj, Grzegorz, 2023. "Interbank asset-liability networks with fire sale management," Working Paper Series 2806, European Central Bank.

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    More about this item

    Keywords

    Fire sales; Liquidity; Overlapping portfolios; Price impact; Stress testing;
    All these keywords.

    JEL classification:

    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • L14 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Transactional Relationships; Contracts and Reputation

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