Knowledge that Transforms

U.S. supervisory stress tests to date have focused on the resilience of large banks to withstand the direct effects of credit and trading shocks. Using data from Depository Trust & Clearing Corporation (DTCC), we apply the Federal Reserve's Comprehensive Capital Analysis and Review (CCAR) supervisory scenarios to evaluate the default of a bank's largest counterparty. We find that indirect effects of this default, through the bank's other counterparties, may be larger than the direct impact on the bank. Further, when taken as a whole, the core banking system has a higher exposure concentration to a single counterparty than does any individual bank holding company. We find that the U.S. banking system's counterparty exposure concentration has risen over the 2013–2015 period. Under the 2015 CCAR this corresponds to a market diversity with just over three counterparties under stress. Our results are the first to evaluate the U.S. credit derivatives market under stress and underscore the importance of a macroprudential perspective on stress testing.

An interdependent network coupling financial institutions’ multiplex (i.e. multi-layer) and financial market infrastructures’ single-layer networks gives a more accurate picture of a financial system's true connective architecture. We examine and compare the main properties of Colombian multiplex and interdependent financial networks. Coupling financial institutions’ multiplex networks with financial market infrastructures’ networks removes modularity, which augments financial instability because the network then fails to isolate feedbacks and limit cascades while it retains its robust-yet-fragile features. Moreover, our analysis highlights the relevance of infrastructure-related systemic risk, corresponding to the effects caused by the improper functioning of financial market infrastructures or by financial market infrastructures acting as conduits for contagion.

Network models, stress testing methods and early warning systems are attracting growing interest both among scholars and practitioners. In this short paper, we illustrate some of the insights they have to offer both in terms of new fundamental scientific understanding of the emergence systemic risk and in terms of concrete applications to the policy areas of financial stability and macro-prudential policy. Finally, we discuss new research pathways to address the challenging questions still open, including multiplex networks, big financial data, and climate-finance.

This paper presents a reduced form credit risk model to study CMBS pricing and CMBS market efficiency during and after the credit crisis with a comprehensive loan, bond and deal level data set. Using a model determined fair value, an automated trading strategy based on a newly determined risk ratio buys undervalued and sells overvalued CMBS. These strategies result in substantial trading profits between November 2007 and June 2015. Controlling for CMBS sector risk factors, we reject CMBS market efficiency over the entire sample period. When we split the sample into the Crisis and Recovery periods, we observe persistent abnormal returns over both subperiods, which is consistent with an inefficient CMBS market. Because the CMBS market appears to be inefficient, our results suggest that the approach presented in this paper may facilitate the increased financial stability of the CRE sector through the better pricing and risk management of CMBS.

This study investigates how the political connections of government bank CEOs affected their banks’ performance during the 2007–2009 financial crisis. Examination of global data shows that government banks with politically connected CEOs experienced significantly higher loan default rates and worse operating performance during the crisis than those without politically connected CEOs. However, these politically connected CEOs were less likely than others to be penalized for the poor performance of their banks. Our evidence suggests that politically connected CEOs of government banks can influence a bank’s lending decisions by using their political power and influence to relax lending standards and to reap private benefits that thus raise their banks’ sensitivity to a crisis.