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Journal of Financial Stability Vol. 71 2024

Shock amplification in an interconnected financial system of banks and investment funds

Matthias Sydow1; Aurore Schilte2; Giovanni Covi3; Marija Deipenbrock1; Leonardo Del Vecchio; Pawel Fiedor4; Gábor Fukker1; Max Gehrend5; Régis Gourdel6; Alberto Grassi1; Björn Hilberg1; Michiel Kaijser7; Georgios Kaoudis8; Luca Mingarelli1; Mattia Montagna1; Thibaut Piquard2; Dilyara Salakhova2,9; Natalia Tente10

1 European Central Bank · 2 Banque de France · 3 Bank of England · 4 Central Bank of Ireland · 5 Central Bank of Luxembourg · 6 Vienna University of Economics and Business · 7 De Nederlandsche Bank · 8 ATEbank (Greece) · 9 Institut d'Economie Scientifique Et de Gestion · 10 Deutsche Bundesbank

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. 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. The main driver of additional bank losses are endogenous market losses generated by investment funds’ asset liquidation.

DOI
10.1016/j.jfs.2024.101234
Volume
71
Pages
101234
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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