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Financial Contagion through Bank Deleveraging: Stylized Facts andSimulations Applied to the Financial Crisis
Thierry Tressel 
WP/10/236
 
 
© 2010 International Monetary Fund WP/

 
IMF Working Paper
Research Department
Financial Contagion through Bank Deleveraging:Stylized Facts and Simulations Applied to the Financial Crisis
 
Prepared by Thierry Tressel
1
 
Authorized for distribution by Gian Maria Milesi-FerrettiOctober 2010
Abstract
 The financial crisis has highlighted the importance of various channels of financial contagion acrosscountries. This paper first presents stylized facts of international banking activities during the crisis.It then describes a simple model of financial contagion based on bank balance sheet identities and behavioral assumptions of deleveraging. Cascade effects can be triggered by bank losses or contractions of interbank lending activities. As a result of shocks on assets or on liabilities of banks,a global deleveraging of international banking activities can occur. Simple simulations are presentedto illustrate the use of the model and the relative importance of contagion channels, relying on bank losses of advanced countries banking systems during the financial crisis to calibrate the shock. Theoutcome of the simulations is compared with the deleveraging observed during the crisis suggestingthat leverage is a major determinant of financial contagion.
This Working Paper should not be reported as representing the views of the IMF.
 The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of theIMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicitcomments and to further debate.
JEL Classification Numbers: F3, F42, G21.Keywords: Financial Contagion, Deleveraging, Funding Shocks, Network Analysis.Author 
s E-Mail Address: ttressel@imf.org
1
This paper draws upon a methodology developed for the IMF Vulnerability Exercise and the IMF-FSB EarlyWarning Exercise. I am very grateful to the Bank for International Settlement for providing access to theConsolidated Banking Statistics and to the Locational Banking Statistics. I would like to thank Laura Kodres,Patrick Mc Guire, Gian-Maria Milesi-Ferretti, Swapan-Kumar Pradhan, Natalia Tamirisa, Nico Valcks, and participants at the Research Department Brown Bag seminar for useful comments and suggestions. I am thankful toMattia Landoni and Sumit Aneja for helpful research assistance.
 
2Contents Page
 I. Introduction ................................................................................................................................ 3
II. Literature ................................................................................................................................... 5
III. Stylized facts: international banks during the crisis ................................................................ 6
A. Data ....................................................................................................................................... 6
B. Stylized Facts ........................................................................................................................ 7
IV. Model of financial contagion ................................................................................................. 10
Asset Shocks ........................................................................................................................ 11
Amplification through Interbank Lending and Fire Sales ................................................... 12
Deleveraging Assumptions .................................................................................................. 14
V. Simulated and actual deleveraging during the financial crisis ................................................ 15
A. Scenario 1: Cross-border Contagion through Deleveraging ............................................... 16
B. Scenario 2: Amplification of the Shock through Interbank Markets .................................. 19
VI. Conclusion ............................................................................................................................. 21
 References.....................................................................................................................................22Figures1.
 
Foreign Claims of Large International Banks........................................................................... 252.
 
Foreign Claims of International Banks by Type of Claims...................................................... 253.
 
Foreign Liabilities to International Bankds by Region.............................................................264.
 
Foreign Claims by Host Region and Home Country of International Banks............................275.
 
Interbank market gross exposures............................................................................................. 286.
 
Effect of an Asset Shock and a Funding Shock on Bank Balance Sheet.................................. 137.
 
The Complete Deleveraging Process.........................................................................................14Tables1.
 
 Network of Bilateral Country Gross Exposures........................................................................282.
 
Capital to Asset Ratio of Large International Banks.................................................................293.
 
Change in Foreign Claims by Type and Sectors.......................................................................304.
 
Deleveraging by Nationality of Banks......................................................................................315.
 
Deleveraging from Host Country Perspective...........................................................................326.
 
Losses of International Banks....................................................................................................337.
 
Reduction in Foreign Liabilities (Scenario 2)............................................................................348.
 
Predicted Reduction in Interbank Claims...................................................................................209.
 
Reduction in Foreign Liabilities (Scenario 3)............................................................................34

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