Balance Sheet Interlinkages and Macro-Financial Risk Analysis in the Euro Area

The financial crisis has highlighted the need for models that can identify counterparty risk exposures and shock transmission processes at the systemic level. We use the euro area financial accounts (flow of funds) data to construct a sector-level network of bilateral balance sheet exposures and show how local shocks can propagate throughout the network and affect the balance sheets in other, even seemingly remote, parts of the financial system. We then use the contingent claims approach to extend this accounting-based network of interlinked exposures to risk-based balance sheets which are sensitive to changes in leverage and asset volatility. We conclude that the bilateral cross-sector exposures in the euro area financial system constitute important channels through which local risk exposures and balance sheet dislocations can be transmitted, with the financial intermediaries playing a key role in the processes. High financial leverage and high asset volatility are found to increase a sector’s vulnerability to shocks and contagion. JEL Classification: C22, E01, E21, E44, F36, G01, G12, G14Balance sheet contagion, contingent claims analysis, financial accounts, macro-prudential analysis, network models, systemic risk

Assessing financial contagion in the interbank market: Maximum entropy versus observed interbank lending patterns

Interbank markets allow banks to cope with specific liquidity shocks. At the same time, they may be a channel allowing a bank default to spread to other banks. This paper analyzes how contagion propagates within the Italian interbank market using a unique data set including actual bilateral exposures. Since information on bilateral exposures was not available in most previous studies, they assumed that banks spread their lending as evenly as possible among all the other banks by maximizing the entropy of interbank linkages. Based on the data available on actual bilateral exposures for all Italian banks, the results obtained by assuming the maximum entropy are compared with those reflecting the observed structure of interbank claims. The comparison indicates that, in line with the thesis prevailing in the literature, the maximum entropy method tends to underestimate the extent of contagion. However, this does not hold in general. Under certain circumstances, depending on the structure of the interbank linkages, the recovery rates of interbank exposures and banksÂ’ capitalization, the maximum entropy approach overestimates the scope for contagion.interbank market, financial contagion, systemic risk, maximum entropy

Managing systemic risk in emergency management, organizational resilience and climate change adaptation: a science-policy roadmap

In urban systems, major risks need to be managed by bringing together emergency management, organisational resilience and climate change adaptation. In this endeavour, policy making must make use of disaster science. This chapter applies the theory of cascading, interconnected and compound risk to the practice of preparing for, managing and responding to threats and hazards. This methodology is illustrated with an example from the United Kingdom, namely the work of the Greater London Authority and its partner organisations. London has long been a champion of resilience strategies for dealing with systemic risk. The chapter investigates the potential and limitations of this approach. There remains a need to identify common points of failure, especially where they relate to interconnected domains and where they are driven by climate change. Radical new thinking is required in order to ensure operational continuity in the face of growing systemic risk

Managing systemic risk in emergency management, organizational resilience and climate change adaptation

Purpose This paper applies the theory of cascading, interconnected and compound risk to the practice of preparing for, managing, and responding to threats and hazards. Our goal is to propose a consistent approach for managing major risk in urban systems by bringing together emergency management, organisational resilience, and climate change adaptation. Design/methodology/approach We develop a theory-building process using an example from the work of the Greater London Authority in the United Kingdom. First, we explore how emergency management approaches systemic risk, including examples from of exercises, contingency plans and responses to complex incidents. Secondly, we analyse how systemic risk is integrated into strategies and practices of climate change adaptation. Thirdly, we consider organisational resilience as a cross cutting element between the approaches. Findings London has long been a champion of resilience strategies for dealing with systemic risk. However, this paper highlights a potential for integrating better the understanding of common points of failure in society and organisations, especially where they relate to interconnected domains and where they are driven by climate change. Originality/value The paper suggests shifting toward the concept of operational continuity to address systemic risk and gaps between Emergency Management, Organizational Resilience and Climate Change Adaptation

Assessing and visualising hazard impacts to enhance the resilience of Critical Infrastructures to urban flooding

This is the final version. Available on open access from Elsevier via the DOI in this recordThe design, construction and maintenance of Critical Infrastructures (CI) is commonly based on standards that are rigorous, so as to withstand any climate or weather-linked pressures. However, due to climate change, climate characteristics may shift, resulting in increased frequency/magnitude of potential failures, or exposure to new unknown risks. As vital components for the normal functioning of modern societies, the resilience of CIs under climate stressors encompasses their structural integrity, their operational elements, and their capacity to maximize business output. In this work, we propose an integrated and participatory methodological approach to enhance the resilience of interconnected CIs to urban flooding under climate change, by assessing the risk and introducing adaptation measures. The main objectives of the proposed methodology and approach are: (i) to provide scientific evidence for better understanding of how future climate regimes might affect normal operation of interconnected CI in urban areas during their lifespan; (ii) to assess the cost-effectiveness of different adaptation measures; (iii) to involve local stakeholders and operators in the co-design of the approach, as well as the assessment and the evaluation of adaptation measures; (iv) to combine computational modelling with advanced 3D visualisation techniques for effectively engaging stakeholders in decision making; (v) to include risk assessment and damage functions co-designed by end-users and local stakeholders; (vi) to integrate all of the aforementioned components in a specifically designed cloud platform as a Decision Support System for end-users, (vii) to validate the DSS by the end users and local stakeholders. The paper presents the computational background and tools. Additionally, it describes a Case Study in Torbay, UK, where the full methodology and the proposed participatory approach have been applied, with all the specifics, i.e., the scenarios of extreme flooding, the numerical and visualization results, the response of the stakeholders and the evaluation of selected adaptation measures.European CommissionEuropean Union FP7Engineering and Physical Sciences Research Council (EPSRC

A network characterization of the interbank exposures in Peru

After the Global Financial Crisis (GFC), systemic risk measurement became crucial for policy makers as well as for academics. We have witnessed an important increase in the number of methodologies proposed. Among such proposals, DebtRank arose as perhaps one of the most relevant in this context, as it resorts to network modeling and captures the all-important aspect of interconnectedness in the financial system. Additionally, within the network modeling approach, there is the multilayer approach, which provides additional insights on the decomposition of systemic risk. In this paper, we apply a multilayer network analysis to study systemic risk in the Peruvian banking system by utilizing DebtRank centrality. The main contributions of this work are as follows: i) It fully characterizes the multilayer exposure network of the Peruvian banking system, and ii) it obtains the systemic risk profile of the banking system according to different types of exposures

THE ITALIAN MANUFACTURING INDUSTRY THROUGH THE GREAT RECESSION: FINANCIAL CONSTRAINTS, PRODUCTIVITY AND SPATIAL NEIGHBORHOOD EFFECTS

La crisi finanziaria esplosa nel 2008 è degenerata in un’aspra e duratura ondata recessiva, che ha colpito l’economia reale a livello internazionale. La presente tesi si propone di contribuire alla letteratura econometrica sull’ultima crisi focalizzandosi su due temi ampiamente dibattuti: vincoli finanziari e produttività totale dei fattori. Il manifatturiero italiano si presenta come scenario preferenziale per condurre l’analisi, tenuto conto della struttura produttiva frammentata e della dipendenza delle imprese dal debito bancario. Si cercherà dapprima di analizzare l’impatto dei vincoli finanziari sulle dinamiche manifatturiere durante la crisi, per poi passare a trattare i temi della rigidità finanziaria e degli effetti di contagio che si sono verificati tra le imprese attraverso il canale del credito commerciale, quali determinanti della probabilità di insolvenza. Infine, il tema delle agglomerazioni tra imprese, di tipo geografico e settoriale, sarà analizzato quale fattore cruciale per la formazione di spillover di produttività, insieme alla capacità innovativa del territorio. I risultati confermano il carattere di pervasività dell’ultima recessione, che alterando le dinamiche manifatturiere ha contribuito ad esacerbare gli episodi di insolvenza. Il possedere una base produttiva clusterizzata ed eterogenea può tuttavia rappresentare ancora un punto di forza, persino all’interno di un contesto operativo plasmato dalla crisi.The financial crisis that erupted in 2008 translated into harsh recessionary effects at an international level, that were passed on to the real economy. A solid recovery is still lagging behind. The dissertation contributes to the econometric literature on the great recession by focusing attention on two debated topics: financing constraints and total factor productivity (TFP). The fragmented and strongly bank-dependent Italian production base is a preferred environment to conduct the analysis. The role played by financing constraints as amplifiers of manufacturing dynamics is firstly investigated. As a second step, financial rigidity of firms and contagion effects that occurred via trade credit interconnections are considered, and jointly modelled as core determinants of distress likelihoods by resorting to spatial econometric techniques. In the last section, geographical and sectoral clustering phenomena are spatially analyzed in order to investigate knowledge spillovers at the micro level. Results highlight the pervasive nature of the last crisis. The harshness of the recessionary effects fostered a change in manufacturing equilibria and caused the proliferation of distress episodes. Nevertheless, a clustered production base still represents a driver for the formation of positive externalities

Climate Stress Test: The Impact of Carbon Price Shock on the Probability of Default in the Hungarian Banking System

This study presents the methodology and results of a transition risk climate stress test carried out for credit institutions, focusing on the methodology of a sectoral module developed for the analysis. Using a sectoral network derived from an input-output table, the sectoral module distributes a price shock between activities with higher greenhouse gas emission intensity and the related sectors. Results suggest that the sectors with the largest exposure to transition are electricity and gas supply. The probability of default for these two sectors may increase by 1.5 to 2.3 percentage points compared to the baseline. The transition risks for various sectors are highly heterogeneous. Based on Monte Carlo simulations, the extent of the transition risks for Hungarian banks also varies significantly. The advantage of this methodology lies in its ability to estimate the magnitude of macroeconomic shocks and the transition differences across sectors, and its ease of integration into stress testing processes