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

Matthias Sydow, Aurore Schilte, Giovanni Covi, Marija Deipenbrock, Leonardo Del Vecchio, Paweł Fiedor, Gábor Fukker, Max Gehrend, Régis Gourdel, Alberto Grassi, Björn Hilberg, Michiel Kaijser, Georgios Kaoudis, Luca Mingarelli, Mattia Montagna, Thibaut Piquard, Dilyara Salakhova, Natalia Tente

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.

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Year of publication:	[2021]
Authors:	Sydow, Matthias ; Schilte, Aurore ; Covi, Giovanni ; Deipenbrock, Marija ; Del Vecchio, Leonardo ; Fiedor, Paweł ; Fukker, Gábor ; Gehrend, Max ; Gourdel, Régis ; Grassi, Alberto ; Hilberg, Björn ; Kaijser, Michiel ; Kaoudis, Georgios ; Mingarelli, Luca ; Montagna, Mattia ; Piquard, Thibaut ; Salakhova, Dilyara ; Tente, Natalia
Publisher:	Frankfurt am Main, Germany : European Central Bank
Subject:	Fire sales \| liquidity \| overlapping portfolios \| price impact \| stress testing \| Investmentfonds \| Investment Fund \| Schock \| Shock \| Portfolio-Management \| Portfolio selection \| Bankenliquidität \| Bank liquidity \| Liquidität \| Liquidity \| Finanzkrise \| Financial crisis \| Stresstest \| Stress test \| Bankenkrise \| Banking crisis \| Finanzsektor \| Financial sector \| Finanzmarkt \| Financial market \| Finanzsystem \| Financial system