Solvency Distress Contagion Risk: Network Structure, Bank Heterogeneity and Systemic Resilience

37 Pages Posted: 2 Mar 2021

See all articles by Kumushoy Abduraimova

Kumushoy Abduraimova

Imperial College London, Business School, Students

Paul Nahai-Williamson

Bank of England

Date Written: February 26, 2021

Abstract

We systematically analyse how network structure and bank characteristics affect solvency distress contagion risk in interbank networks. As interbank networks become more connected and more regular in structure, the contagion risk of system-wide shocks and individual bank defaults initially increases and then decreases, all else being equal. The low density heterogeneous network structures that typify real interbank networks are particularly prone to solvency distress contagion risk, when banks are similar in balance sheet size and capitalisation. However, when networks are calibrated to UK data, the higher capitalisation of large, highly-connected banks relative to their interbank exposures significantly increases the resilience of the system and reduces the importance of network structure. These findings reinforce the importance and effectiveness of imposing higher capital buffers on systemically important banks and of policies that limit interbank exposures. We also demonstrate that for real-world interbank networks, simple network metrics other than individual bank connectedness do not provide robust indicators for monitoring solvency contagion risk, suggesting that policymakers should continue efforts to model these risks explicitly rather than rely on simple aggregate indicators.

Keywords: Financial networks, systemic risk, financial contagion, banking policy

JEL Classification: C54, D85, G01, G21, G28

Suggested Citation

Abduraimova, Kumushoy and Nahai-Williamson, Paul, Solvency Distress Contagion Risk: Network Structure, Bank Heterogeneity and Systemic Resilience (February 26, 2021). Bank of England Working Paper No. 909, Available at SSRN: https://ssrn.com/abstract=3796283 or http://dx.doi.org/10.2139/ssrn.3796283

Kumushoy Abduraimova

Imperial College London, Business School, Students

South Kensington Campus
Exhibition Road
London SW7 2AZ, SW7 2AZ
United Kingdom

Paul Nahai-Williamson (Contact Author)

Bank of England ( email )

Threadneedle Street
London, EC2R 8AH
United Kingdom

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