Abstract
In this paper, we use an agent-based simulation combined with innovative calibration techniques to model the European banking system as accurately as possible. Our novel contribution to the recent literature involves adding bank heterogeneity to the model. To estimate the levels of shock propagation in large-scale events, such as the default of multiple banks, as well as smaller events, such as the defaults of an individual bank, we provide granular modeling of bank behavior. We extend the existing network approach by adding the ability to model banks of various sizes and the detailed connections of 286 individual banks across 9 European countries. Our main results show how the failure of a large Italian bank or of a medium-sized German bank might create a cascade of problems for the entire European banking sector. Our results reveal that Italian banks make a much larger contribution to systemic risk than German or French banks. We believe that computational experiments in this model provide valuable insights into systemic risk within the European banking system for policy makers when estimating the systemic effects of individual bank defaults. From a regulatory perspective, we recommend the introduction of a tighter limit for all types of inter-bank exposures than the recent limit of 25% of Tier 1 capital. Moreover, we propose an increase in the risk-weights for exposures to large banks in Germany, France, Italy, and Spain.
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Notes
The model as described in this paper allows banks to operate with capital close to zero. However, in reality, supervisors claim that they would revoke the license much earlier, such as at a 4.5% capital-to-asset ratio. However, given a major systemic shock, regulators cannot easily afford to immediately close down banks and the regulatory behaviour is subject to dynamic inconsistency. The rationale is discussed in greater detail in Klinger and Teply (2014a).
We should note that the Austrian banking system has not been reporting strong capital positions in the last years, although it is improving recently. However, the system’s weak capital position was primarily the result of the poor performance of the sector’s subsidiaries in Central and Eastern Europe (including higher credit risk in Ukraine and bank taxes in Hungary) rather than from losses stemming from the interbank market.
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Acknowledgements
This research was supported by the Czech Science Foundation (Project No. GA 17-02509S) and University of Economics in Prague (Project No. VŠE IP100040). We also thank to anonymous referees for their valuable comments.
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Teply, P., Klinger, T. Agent-based modeling of systemic risk in the European banking sector. J Econ Interact Coord 14, 811–833 (2019). https://doi.org/10.1007/s11403-018-0226-7
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DOI: https://doi.org/10.1007/s11403-018-0226-7