Bank lending and systemic risk: A financial-real sector network approach with feedback

Abstract

We simulate shocks to the real sector and evaluate how the financial system reacts and amplifies these events using unique Brazilian loan-level data between banks and banks and firms. Our analysis considers the feedback behavior that exists between the financial and real sectors through a micro-level financial accelerator. We find a strong “network effect” in which the network structure can either attenuate or amplify shocks from the real sector and thus plays a major role in contagion processes. We also find that government-owned banks are the most susceptible banks to receiving shocks from firms of any economic sector. There is empirical evidence to support the claim that more diversified portfolios of banks contribute to higher sector riskiness levels. Our results suggest that systemic risk models should account for the interconnectedness among economic agents—such as the interbank and real and financial sector linkages—in a multilayer approach. Overall, we show that the feedback between the real and financial sector matters in systemic risk estimation and most models that do not take into consideration could be severely underestimating systemic risk.