Emergence of the EU corporate lending network

ABSTRACT This paper uses network formation techniques based on a theoretical framework developed by Hałaj and Kok to construct networks of lending relationships between a large sample of banks and nonbanks in the EU. The model provides an assessment not onlyof how banks are directly related to each other in the interbank market, but also how they may be indirectly related (due to common exposures) via their corporate lending relationships.We illustrate how the model can be used to conduct counterfactual simulations of the contagion effects arising when individual - or groups of - banks and firms are hit by shocks. This could allow policy makers to gauge specific vulnerabilities in the financial system evolving around the lending relationships between banks and their (corporate) borrowers. Furthermore, we show that the modeling framework can be used by micro- and macroprudential authorities to analyze the impact of varying banks' large exposure limits as a way to mitigate contagion effects within and beyond the financial system.