Macro-Networks: An application to euro area financial accounts

Abstract

This paper develops a financial network, designated the “Macro-Network”, that depicts the connections between the main financial and non-financial sectors of the economy in the various financial instruments of the euro area. The Macro-Network comprises of linkages across financial and non-financial sectors in each country. These country-level sector networks are then connected by the cross-border links between the individual banking sectors. Using the Macro-Network to simulate financial shocks, we find that the propagation effects depend on the underlying network structure, which evolves over time. After the financial crisis, bilateral linkages contracted sharply, reflecting the surge in counterparty risk and the de-leveraging processes. Nonetheless, our analysis suggests that even after this process, vulnerabilities remained in the euro area financial system, while a more diversified portfolio of cross-border exposures might mitigate the shock effects. We identify sectors which are most relevant for the propagation of financial shocks in the Macro-Network.