Dynamical Macro-Prudential Stress Testing Using Network Theory

Abstract

The increasing frequency and scope of financial crises has made global financial stability one of the major concerns of economic policy and decision makers. Under this highly complex environment, financial and banking supervision has to be thought as a systemic task, focusing not only on the strength of the institutions but also on the interdependent relations among them, unraveling the structure and dynamic of the system under surveillance. Using network theory, we developed a dynamic model to reveal the systemic structure of a banking system, to analyze its sensibility to external shocks and to evaluate the presence of contagious underlying features of the system. As a case study, we make use of the Venezuelan banking system in the period of 1998-2013. The introduced model was able to capture, in a dynamic way, changes in the structure of the system and the sensibility of banks portfolio to external shocks. Results suggest the fruitfulness of this kind of approach to policy makers and supervision agencies to address macro-prudential dynamical stress testing and regulation.

Keywords: Financial Networks, Interdependence, Contagion, Banking System, Venezuela, Macro-prudential

JEL Classification: G21, D85, N26, G18