Intra-Portfolio Systemic Contagion

Abstract

Traditional approaches to credit risk evaluation have looked at a portfolio’s obligors as separate elements. However, daily bank practice suggests that there can be contagion effects between obligors, a fact that through the current normative has been explicitly acknowledged by EU regulation authorities. The “group of connected clients” is the key-concept for this revolutionary change: EBA requires banks firstly to identify such groups according to a set of different criteria and then to treat each of them as a single risk unit. This normative challenges banks to adopt concepts and methods rather new with respect to its professional background and practice. Here, its conceptual and practical implications are discussed, and some of its main flaws are evidenced: its framework remains static instead of dynamic, local instead of systemic, threshold-based instead of continuous variations. Therefore, if on one side this normative introduces the revolutionary concept of the groups of connected clients among risk evaluation criteria, on the other side it remains still entrapped into the traditional view and leaves untouched the risk evaluation of “non-dominated” clients. Hence, it should be considered as a step towards a full new paradigm, which had to look at portfolios as inter-organizational networks, more or less subjected to “failure cascades” depending on its specific structures. To this aim, it is required to design a new rating system with which single obligor’s risk evaluation should be measured precisely and in relation with the position they cover within the whole portfolio.

Keywords: credit risk evaluation, complexity economics, economic dependency, economic networks, failure cascades, financial contagion, groups of connected clients, inter-firm networks, network interconnectedness

JEL Classification: G28, L14, O16