Assessing the interconnectedness and systemic risk contagion in the Chinese banking network

Danyang Shi,Shaoyi Feng,Pei Wang,Amuji Bridget Nnenna,Ming Qi

doi:10.1108/ijoem-08-2021-1331

Danyang Shi, Shaoyi Feng + Show 3 more

Open Access

https://doi.org/10.1108/ijoem-08-2021-1331

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Abstract

PurposeIn this paper, the authors use the balance sheet data to investigate the interconnectedness and risk contagion effects in China's banking sector. They firstly study the network structure and centrality of the interbank network. Then, they investigate how and to what extent the credit shock and liquidity shock can lead to the risk propagation in the banking network.Design/methodology/approachReferring to the theoretical framework by Haldane and May (2011), this paper uses the network topology theory to analyze the contagion mechanism of credit shock and liquidity shock. Centrality measures and log-log plot are used to evaluate the interconnectedness of China's banking network.FindingsThe network topology has shown clustering effects of large banks in China's financial network. If the Industrial and Commercial Bank of China (ICBC) is in distress, the credit shock has little impact on the Chinese banking sector. However, the liquidity shock has shown more substantial effects than that of the credit shock. The discount rate and the rollover ratio play significant roles in determining the contagion effects. If the credit shock and liquidity shock coincide, the contagion effects will be amplified.Research limitations/implicationsThe results of this paper reveal the network structure of China's interbank market and the resilience of banking system to the adverse shock. The findings are valuable for regulators to make policies and supervise the systemic important banks.Originality/valueThe balance sheet data of different types of banks are used to construct a bilateral exposure matrix. Based on the matrix, this paper investigates the knock-on effects of credit shock triggered by the debt default in the interbank market, the knock-on effects of liquidity effects, which is featured by “fire sale” of bank assets, and the contagion effects of combined shocks.

Highlights

China’s banking system is characterized by the complex and diverse participants, including policy banks, state-owned commercial banks, joint-stock banks, urban commercial banks, rural commercial banks and foreign banks
Two primary sources of systemic risk are relationship credit and related exposure Systemic risk comes from the balance sheet effect, asset price effect and information contagion effect The possibility of default contagion is not high, but it cannot be completely ruled out The importance of large and well-connected banks in system stability is proportional to the size Under the completely decentralized market structure, the contagion risk of the interbank market is minimal Sovereign credit risk is the main source of contagion in the banking network Scale is not the only determinant of the characters of the network
If the discount rate is large, even if the default loss rate is low, there will be a high number of bank distress

Summary

Introduction

China’s banking system is characterized by the complex and diverse participants, including policy banks, state-owned commercial banks, joint-stock banks, urban commercial banks, rural commercial banks and foreign banks. In 2019, the capital adequacy ratio of Baoshang Bank became insufficient This event led to the default of 6.5 billion yuan bonds and 586 million yuan interests, which brought about the shortterm liquidity impact on the financial market. The systemically important banks are categorized into five groups and required to maintain additional capital to improve the stability of the banking system [3]. All these policies have implied that the systemic risk contagion is of great concern by both academic and regulators. The last section finishes with the conclusion and discussion of policy implications

Literature review

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Conclusions and discussion