Essays on financial stability

Abstract

The thesis analyses dynamics of systemic risk and contagion in securitization, interbank and derivatives markets, and the subsequent implications for financial stability and macroprudential policy. In doing so, three distinctive lines of research are pursued. First, we examine the impact of securitization on bank stability and systemic risk. Following this, we analyse distress spillover from the OTC derivatives market into the interbank market, due to the interaction between margin procyclicality in OTC derivatives markets, and funding liquidity risk in the interbank market. Finally, we develop a macroprudential stress test, that explicitly links liquidity risk and solvency risk of banks, as well as account for interconnectedness among them.

We provide evidence that securitization activities are destabilizing at both the individual bank level and the banking system level, and tend to increase commonality of asset returns among banks leading to increased interconnectedness and systemic risk. Moreover, we show that distress due to margin procyclicality in the OTC derivatives market can spillover to the interbank market leading to episodes of systemic liquidity risk. We also show that central clearing might increase the possibility of systemic liquidity risk due to tight margin requirements and the timing of cash flows required from banks. Further, using the proposed stress test, we effectively identify the systemic vulnerability of individual banks and the resilience of the banking system as a whole to economic shocks.

The results of this thesis have far-reaching policy implications. First, given the current increasing pace in monetary policy tightening, our findings on the destabilizing effect of securitization activities are of great interest to policy makers in their attempts to revive securitization markets, as they provide a framework for regulators to think about the effects of securitization at both the bank level and the banking system level. Moreover, our findings on the negative consequences of margin requirements should inform regulators about the importance of striking the balance between limiting counterparty credit risk through tight margin requirements, and the side effect of increasing the possibility and magnitude of systemic liquidity crises. Finally, the proposed stress test provides an effective tool for the banking system supervisors to analyse the current state of the system stability and to monitor the evolution of contagion and systemic risk within the system.

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Identifiers

ORCID for Mohamed Bakoush: orcid.org/0000-0001-9624-9828

ORCID for Simon Wolfe: orcid.org/0000-0001-9815-9535

ORCID for Enrico Gerding: orcid.org/0000-0001-7200-552X

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