contagion
European Economic Review 48 (2004) 827 – 849 www.elsevier.com/locate/econbase Estimating bilateral exposures in the German interbank market: Is there a danger of contagion?
Christian Upper, Andreas Worms∗
Deutsche Bundesbank, Economics Department, Wilhelm-Epstein-Str. 14,
D-60431 Frankfurt am Main, Germany
Received 9 September 2003; accepted 20 December 2003
Abstract
Credit risk associated with interbank lending may lead to domino e ects, where the failure of one bank results in the failure of other banks not directly a ected by the initial shock. Recent work in economic theory shows that this risk of contagion depends on the precise pattern of interbank linkages. We use balance sheet information to estimate a matrix of bilateral credit relationships for the German banking system and test whether the breakdown of a single bank can lead to contagion. We ÿnd that in the absence of a safety net, there is considerable scope for contagion that could a ect a large proportion of the banking system. The ÿnancial safety net (in this case institutional guarantees for saving banks and cooperative banks) considerably reduces—but does not eliminate—the danger of contagion. Even so, the failure of a single bank could lead to the breakdown of up to 15% of the banking system in terms of assets. c 2003 Elsevier B.V. All rights reserved.
JEL classiÿcation: G21; G28
Keywords: Contagion; Interbank market; Regulation of banks
1. Introduction
Credit risk associated with interbank lending may lead to domino e ects, where the failure of a bank results in the failure of other banks even if the latter are not directly a ected by the initial shock. Recent work in economic theory shows that this risk of contagion depends on the precise pattern of interbank linkages. For example, in the model of Allen and Gale (2000) banks hold deposits with banks of other regions in
∗
Corresponding author. Tel.: +49-69-9566-2398/3721; fax: +49-69-9566-3082.
E-mail
Christian Upper, Andreas Worms∗
Deutsche Bundesbank, Economics Department, Wilhelm-Epstein-Str. 14,
D-60431 Frankfurt am Main, Germany
Received 9 September 2003; accepted 20 December 2003
Abstract
Credit risk associated with interbank lending may lead to domino e ects, where the failure of one bank results in the failure of other banks not directly a ected by the initial shock. Recent work in economic theory shows that this risk of contagion depends on the precise pattern of interbank linkages. We use balance sheet information to estimate a matrix of bilateral credit relationships for the German banking system and test whether the breakdown of a single bank can lead to contagion. We ÿnd that in the absence of a safety net, there is considerable scope for contagion that could a ect a large proportion of the banking system. The ÿnancial safety net (in this case institutional guarantees for saving banks and cooperative banks) considerably reduces—but does not eliminate—the danger of contagion. Even so, the failure of a single bank could lead to the breakdown of up to 15% of the banking system in terms of assets. c 2003 Elsevier B.V. All rights reserved.
JEL classiÿcation: G21; G28
Keywords: Contagion; Interbank market; Regulation of banks
1. Introduction
Credit risk associated with interbank lending may lead to domino e ects, where the failure of a bank results in the failure of other banks even if the latter are not directly a ected by the initial shock. Recent work in economic theory shows that this risk of contagion depends on the precise pattern of interbank linkages. For example, in the model of Allen and Gale (2000) banks hold deposits with banks of other regions in
∗
Corresponding author. Tel.: +49-69-9566-2398/3721; fax: +49-69-9566-3082.
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