Financial networks and default-driven shocks: an application to banking systems Francisco Hawas (*) Research Assistant Mathematical Modeling Center Universidad de Chile (*) Joint project with Arturo Cifuentes and Alejandro Jofré

Motivation Financial crisis ( ) – Size of banks? – Number of banks? – Degree of Interconnections? Direct Indirect Regulatory and academic interest on the topic of financial networks

Overview Problems from the financial regulator viewpoint: – Liquidity risk Inability to pay, not necessary a balance sheet problem – Solvency risk Balance sheet problem This project will focus, initially, on the solvency aspects – Liquidity will be left for a second stage

Bank’s Balance sheet Assets Liabilities Cash, C k Loans to third parties, L k Loans to other banks, B k Deposits at CB, θ D k Investments, I k Deposits, D k Equity, E k Debt to CB, Ф k Debts to other banks, H k

Model Overview

Bank 1 Bank N Gaussian Copula [ε, ρ] Loans to third parties Indirect connection

Model Overview

End point: 1)All Banks have defaulted 2)End of simulation time

Example Number of Banks Number of connections Time to first default (Mean)

Example Number of Banks Number of connections Time to first default (Mean)

Topics to investigate Influence of balance sheet structure – Leverage ratio Central Bank policy – Effect of Θ – Rescue loan policy Effects of number of banks – No diversification effects? Effects of number of connections – Selection of counterparty is random

Important questions to be answered Does diversification improve system resilience? Is interconnection (degree of) harmful for the financial system? Importance of correlation at a fundamental level… important? Is the dynamics of correlation important? – Steady, peak, steady, relevant? What would be the effect of a run on a bank? Or the system? At which speed the system turn into unstable mode?