We analyze the effects on financial stability of the interplay between climate transition risk and market conditions, such as recovery rate and asset price volatility. To this end, we extend the framework of the climate stress-test of the financial system by including an ex-ante network valuation of financial assets which accounts for asset price volatility as well as for endogenous recovery rate on interbank assets. Moreover, we also consider the dynamics of indirect contagion of banks and investment funds, which are key players in the low carbon transition, via exposures to the same asset classes. We derive some analytical results and we apply the model to a unique supervisory dataset in a range of climate policy scenarios and market conditions. In the event of a disorderly low-carbon transition, stronger market conditions allow to reach more ambitious climate policies at the same level of financial risk.

In financial stability, it is essential to know the determinants of interest rates in interbank markets because they are important vehicles for liquidity allocation among banks and are relevant for monetary policy transmission. Recent research indicates that banks with excess liquidity exercise their market power by rationing liquidity during periods of financial stress. This confirms the value of knowing the banks connections and identifying liquidity spreaders in such markets to manage contagion risk, liquidity hoarding and to preserve financial stability. In addition to well studied bank features such as size, liquidity and credit risk, we study which network metrics relate to interest rates during different periods. Using transaction level data on unsecured and secured lending, we apply an approach that employs network theory, econometric models and machine learning to analyze the structural properties of the secured and unsecured interbank markets in Mexico. Our findings support the “too-interconnected-to-fail” hypothesis. In the secured interbank market, PageRank shows a relationship with interest rates, while metrics associated with the notion of influence and systemic risk (Katz and DebtRank) are relevant in the unsecured interbank market. In general, a bank with high centrality lends at higher rates and gets funding at lower rates.