Network Analysis of Exchange Rate Shocks: implications for financial stability in Brazil

This paper uses a network-based framework to examine the propagation of exchange rate shocks through the economy. We use a comprehensive set of supervisory, granular, and unique datasets from Brazil to construct an economy-wide network of exposures from 2015 to 2022, which includes a representative set of financial institutions, both banking and nonbanking, the corporate sector, and bilateral exposure linkages encompassing credit and funding risks. Our findings reveal significant disparities in how exchange rate shocks impact different sectors. Financial institutions generally benefit from positive exchange rate shocks due to their net foreign-denominated assets, whereas nonfinancial firms incur losses, particularly those with substantial foreign debt. However, contagion effects indicate that even sectors that are initially better off can experience substantial indirect losses, highlighting the complexity of risks in the financial network. Despite vulnerabilities in segments such as development banks and non-bank financial institutions, adequate regulatory capital maintains and supports overall financial stability. These insights underscore the importance of incorporating network structures in regulatory frameworks and stress-testing methodologies, offering crucial implications for policymakers seeking to improve financial stability and mitigate systemic risks.