Contagion in the ASEAN Interbank Market: Before and after the ASEAN Economic Community (AEC)

Abstract

Interbank activities including bilateral deposits and loans are widely considered a direct channel for financial contagion. Through this channel, the failure of one bank may trigger the insolvency of other banks, causing a systemic failure or large loss of assets. This research empirically tests for the possibility of contagion in Southeast Asian banks in the context of the increasingly more integrated ASEAN Economic Community (AEC). Data on bilateral deposits and loans between 234 banks located in all ten Southeast Asian countries are collected. Simulations based on empirical data are performed to examine the potential for contagion. In the simulations, the bankruptcy of a single bank is initially assumed. Then, bankruptcy and losses incurred to other banks via the aforementioned interbank exposures are estimated. Allen and Gale (1998, 2000) contagion model and Upper and Worms (2004) model are extended to account for the characteristics of the ASEAN financial network. The findings indicate that the more integrated and more complete ASEAN banking system under AEC is more tolerant to contagion than individual national banking networks.