On the Computational Complexity of Measuring Global Stability of Banking Networks

Threats on the stability of a financial system may severely affect the functioning of the entire economy, and thus considerable emphasis is placed on the analyzing the cause and effect of such threats. The financial crisis in the current and past decade has shown that one important cause of instability in global markets is the so-called financial contagion, namely the spreading of instabilities or failures of individual components of the network to other, perhaps healthier, components. This leads to a natural question of whether the regulatory authorities could have predicted and perhaps mitigated the current economic crisis by effective computations of some stability measure of the banking networks. Motivated by such observations, we consider the problem of defining and evaluating stabilities of both homogeneous and heterogeneous banking networks against propagation of synchronous idiosyncratic shocks given to a subset of banks. We formalize the homogeneous banking network model of Nier et al. and its corresponding heterogeneous version, formalize the synchronous shock propagation procedures, define two appropriate stability measures and investigate the computational complexities of evaluating these measures for various network topologies and parameters of interest. Our results and proofs also shed some light on the properties of topologies and parameters of the network that may lead to higher or lower stabilities.Comment: to appear in Algorithmic

Bank insolvencies, priority claims and systemic risk

We review an extensive literature debating the merits of alternative priority structures for banking liabilities put forward by financial economists, legal scholars and policymakers. Up to now, this work has focused exclusively on the relative advantages of each group of creditors to monitor the activities of bankers. We argue that systemic risk is another dimension that this discussion must include. The main message of our work is that when bank failures are contagious then when regulators assign priority rights need also to take into account how the bankruptcy resolution of one institution might affect the survival of other institutions that have acted as its creditors. When the network structure is fixed the solution is straightforward. Other banks should have priority to minimize the risk of their downfall. However, if the choice of policy can affect the structure of the network, policy design becomes more complex.This is a fruitful avenue for future research

Systemic importance of financial institutions: regulations, research, open issues, proposals

In the field of risk management, scholars began to bring together the quantitative methodologies with the banking management issues about 30 years ago, with a special focus on market, credit and operational risks. After the systemic effects of banks defaults during the recent financial crisis, and despite a huge amount of literature in the last years concerning the systemic risk, no standard methodologies have been set up to now. Even the new Basel 3 regulation has adopted a heuristic indicator-based approach, quite far from an effective quantitative tool. In this paper, we refer to the different pieces of the puzzle: definition of systemic risk, a set of coherent and useful measures, the computability of these measures, the data set structure. In this challenging field, we aim to build a comprehensive picture of the state of the art, to illustrate the open issues, and to outline some paths for a more successful future research. This work appropriately integrates other useful surveys and it is directed to both academic researchers and practitioners

Strength of Hydrogen Bond Network Takes Crucial Roles in the Dissociation Process of Inhibitors from the HIV-1 Protease Binding Pocket

To understand the underlying mechanisms of significant differences in dissociation rate constant among different inhibitors for HIV-1 protease, we performed steered molecular dynamics (SMD) simulations to analyze the entire dissociation processes of inhibitors from the binding pocket of protease at atomistic details. We found that the strength of hydrogen bond network between inhibitor and the protease takes crucial roles in the dissociation process. We showed that the hydrogen bond network in the cyclic urea inhibitors AHA001/XK263 is less stable than that of the approved inhibitor ABT538 because of their large differences in the structures of the networks. In the cyclic urea inhibitor bound complex, the hydrogen bonds often distribute at the flap tips and the active site. In contrast, there are additional accessorial hydrogen bonds formed at the lateral sides of the flaps and the active site in the ABT538 bound complex, which take crucial roles in stabilizing the hydrogen bond network. In addition, the water molecule W301 also plays important roles in stabilizing the hydrogen bond network through its flexible movement by acting as a collision buffer and helping the rebinding of hydrogen bonds at the flap tips. Because of its high stability, the hydrogen bond network of ABT538 complex can work together with the hydrophobic clusters to resist the dissociation, resulting in much lower dissociation rate constant than those of cyclic urea inhibitor complexes. This study may provide useful guidelines for design of novel potent inhibitors with optimized interactions

Should There Be Intraday Money Markets?

In this paper, we consider the case for an intraday market for reserves. We discuss the separate roles of intraday and overnight reserves and argue that an intraday market could be organized in the same way as the overnight market. We present arguments for and against a market for intraday reserves when the marginal cost of overnight reserves is positive. We also consider how reserves should be supplied when the cost of overnight reserves is zero. In that case, the distinction between overnight and intraday reserves becomes blurred, raising an important question: What is the role of the overnight market

Interbank borrowing and lending between financially constrained banks

Some stylized facts about transactions among banks are not easily reconciled with coinsurance of short-term liquidity risks. In our model, interbank markets play a different role. We argue that lending to another bank can reduce a bank’s overall portfolio risk through diversification. If insolvency is costly, this diversification improves the interbank lender's funding liquidity, boosting credit supply to nonbanks. However, diversification comes at an endogenous cost that depends on bank-specific factors of interbank borrower and lender. The model provides a framework for understanding the importance of interbank lending for aggregate credit supply and the stability of banking systems. The model’s predictions are consistent with evidence documented in the literature that other theories cannot consistently explain

Complex financial networks and systemic risk: a review

In this paper we review recent advances in financial economics in relation to the measurement of systemic risk. We start by reviewing studies that apply traditional measures of risk to financial institutions. However, the main focus of the review is on studies that use network analysis paying special attention to those that apply complex analysis techniques. Applications of these techniques for the analysis and pricing of systemic risk has already provided significant benefits at least at the conceptual level but it also looks very promising from a practical point of view

Loan Loss Provision: Some Empirical Evidence for Italian Banks

This paper uses data from a panel of more than 400 Italian banks for the period 2001 - 2012 to examine the main determinants of loan loss provision (LLP), which are classified as either discretionary (income smoothing, capital management, signalling) or non-discretionary (related to the business cycle). The results suggest that LLP in Italian banks is driven mainly by non-discretionary components, especially during the recession of 2008-2012, and is consistent with a countercyclical behavior of LLP. Further, it is generally less pro cyclical (although not during the recent economic crisis) in the case of local banks: since their loans are more collateralised, their behaviour is more strongly affected by supervisory activity, their initial coverage ratio being lower than for other banks

How Smart are Investors after the Subprime Mortgage Crisis? Evidence from the Securitization Market

Two factors have proven to be strongly relevant for the subprime mortgage crisis. The first is the lack of screening incentives of originators, which had not been anticipated by investors. The second is that investors relied too much on credit ratings. We examine whether investors have learned from these shortcomings. On the basis of securitizations from 2010 and 2011, we find that investors require a significantly higher risk premium when there is a high degree of asymmetric information. The credit spreads of information sensitive tranches are significantly higher if originators do not retain a part of the securitization or if they choose vertical slice retention instead of retaining the equity tranche. Moreover, the relevance of credit ratings in comparison to other credit factors has significantly decreased. Apparently, investors mainly consider ratings to discriminate between information sensitive and information insensitive tranches, beyond that they rely on their own risk analysis. This suggests that investors have learned their lesson from the subprime mortgage crisis