Shock Amplification in an Interconnected Financial System of Banks and Investment Funds

66 Pages Posted: 10 Aug 2021

See all articles by Matthias Sydow

Matthias Sydow

European Central Bank (ECB)

Aurore Schilte

Banque de France

Giovanni Covi

European Central Bank (ECB); University of Verona

Marija Deipenbrock

European Central Bank (ECB)

Leonardo Del Vecchio

Bank of Italy; University of Rome I - Department of Statistical Sciences

Pawel Fiedor

Central Bank of Ireland

Gábor Fukker

European Central Bank (ECB)

Max Gehrend

Banque Centrale du Luxembourg

Régis Gourdel

European Central Bank (ECB)

Alberto Grassi

European Central Bank (ECB)

Björn Hilberg

Goethe University Frankfurt

Michiel Kaijser

European Central Bank (ECB)

Georgios Kaoudis

Bank of Greece

Luca Mingarelli

European Central Bank (ECB)

Mattia Montagna

European Central Bank (ECB)

Thibaut Piquard

Banque de France; Paris School of Economics (PSE)

Dilyara Salakhova

European Central Bank (ECB)

Natalia Tente

Deutsche Bundesbank

Date Written: August, 2021

Abstract

This paper shows how the combined endogenous reaction of banks and investment funds to an exogenous shock can amplify or dampen losses to the financial system compared to results from single-sector stress testing models. We build a new model of contagion propagation using a very large and granular data set for the euro area. Based on the economic shock caused by the Covid-19 outbreak, we model three sources of exogenous shocks: a default shock, a market shock and a redemption shock. Our contagion mechanism operates through a dual channel of liquidity and solvency risk. The joint modelling of banks and funds provides new insights for the assessment of financial stability risks. Our analysis reveals that adding the fund sector to our model for banks leads to additional losses through fire sales and a further depletion of banks’ capital ratios by around one percentage point.

JEL Classification: D85, G01, G21, G23, L14

Suggested Citation

Sydow, Matthias and schilte, aurore and Covi, Giovanni and Deipenbrock, Marija and Del Vecchio, Leonardo and Fiedor, Pawel and Fukker, Gábor and Gehrend, Max and Gourdel, Régis and Grassi, Alberto and Hilberg, Björn and Kaijser, Michiel and Kaoudis, Georgios and Mingarelli, Luca and Montagna, Mattia and Piquard, Thibaut and Piquard, Thibaut and Salakhova, Dilyara and Tente, Natalia, Shock Amplification in an Interconnected Financial System of Banks and Investment Funds (August, 2021). ECB Working Paper No. 2021/2581, Available at SSRN: https://ssrn.com/abstract=3900850 or http://dx.doi.org/10.2139/ssrn.3900850

Matthias Sydow (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Aurore Schilte

Banque de France ( email )

Paris
France

Giovanni Covi

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

University of Verona ( email )

Via dell'Artigliere, 8
Verona, 37129
Italy

Marija Deipenbrock

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Leonardo Del Vecchio

Bank of Italy ( email )

Via Nazionale 91
Rome, 00184
Italy

University of Rome I - Department of Statistical Sciences ( email )

Piazzale Aldo Moro, 5
Rome, 00185
Italy

Pawel Fiedor

Central Bank of Ireland ( email )

P.O. Box 559
Dame Street
Dublin, 2
Ireland

Gábor Fukker

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Max Gehrend

Banque Centrale du Luxembourg ( email )

2, boulevard Royal
Luxembourg, L-2983
Luxembourg

Régis Gourdel

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Alberto Grassi

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Björn Hilberg

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Michiel Kaijser

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Georgios Kaoudis

Bank of Greece ( email )

21 E. Venizelos Avenue
GR 102 50 Athens
Greece

Luca Mingarelli

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Mattia Montagna

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Thibaut Piquard

Banque de France ( email )

Paris
France

Paris School of Economics (PSE) ( email )

48 Boulevard Jourdan
Paris, 75014 75014
France

Dilyara Salakhova

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

Natalia Tente

Deutsche Bundesbank ( email )

Wilhelm-Epstein-Str. 14
Frankfurt/Main, 60431
Germany

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