Financial contagion

The recent financial crisis, while having its roots in the US, spread globally in a very short span of time. Banks' interdependence played an obvious role but not much is known about world financial contagion channels. In a recent TILEC discussion paper, TILEC members Hans Degryse and María Fabiana Penas and co-author Muhammad Ather Elahi (Tilburg University) examine cross-border contagion risk over the period 1999-2006. To that purpose they use aggregate cross-border exposures of banks in seventeen countries. They find that a shock which affects the liabilities of one country may undermine the stability of the entire financial system. For instance, a shock wiping out 25% of US cross-border liabilities against non-US banks could lead to bank contagion eroding at least 94% of the recipient countries&acute banking assets. They also find that since 2006 a shock to Eastern Europe, Turkey and Russia affects most countries. Simulations also reveal that the speed of contagion has increased in recent years resulting in a higher number of directly exposed banking systems. Finally, they find that contagion is more widespread in geographical proximities. Ironically, the US is the only country immune to cross-border shocks stemming from other countries!