IMF Working Papers

Interconnectedness, Systemic Crises and Recessions

By Marco A Espinosa-Vega, Steven Russell

February 27, 2015

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Marco A Espinosa-Vega, and Steven Russell. Interconnectedness, Systemic Crises and Recessions, (USA: International Monetary Fund, 2015) accessed November 5, 2024
Disclaimer: This Working Paper should not be reported as representing the views of the IMF.The views expressed in this Working Paper are those of the author(s) and do not necessarily represent those of the IMF or IMF policy. Working Papers describe research in progress by the author(s) and are published to elicit comments and to further debate

Summary

This relatively simple model attempts to capture and integrate four widely held views about financial crises. [1] Interconnectedness among financial institutions (banks) can play a major role in precipitating systemic financial crises. [2] Lack of information about the quality of bank portfolios also plays a role in precipitating systemic crises. [3] Financial crises, particularly systemic ones, are often followed by severe, lengthy recessions. [4] Loss of confidence in the financial system is partly responsible for the length and severity of these recessions. In the model, banks make decisions about initiating and liquidating risky loans. Interconnectedness among their asset portfolios can obscure information about these portfolios, causing them to make inefficient decisions about liquidation, and about retention of the managers who assess credit risk. These decisions can increase the depth of recessions, and they can produce systemic financial crises. They can also reduce the effectiveness of future bank risk assessment, increasing the probability of lengthy, severe recessions. The government, acting in the interest of current and future depositors, may wish to increase the transparency of bank portfolios by limiting interconnectedness. The optimal degree of regulation, which may depend on depositors’ degree of risk aversion, may not eliminate financial crises.

Subject: Banking, Distressed assets, Financial contagion, Financial crises, Financial institutions, Financial sector policy and analysis, Loans, Systemic crises

Keywords: Asset portfolio, Asset portfolio consist, Bank asset liquidation, Bank B, Banks' manager, Distressed assets, Diversification regime, Financial contagion, Financial crisis, Interconnectedness, Loans, Portfolio diversification, Recession, Return outcome, Systemic crises, Systemic risk, WP

Publication Details

  • Pages:

    48

  • Volume:

    ---

  • DOI:

    ---

  • Issue:

    ---

  • Series:

    Working Paper No. 2015/046

  • Stock No:

    WPIEA2015046

  • ISBN:

    9781498386029

  • ISSN:

    1018-5941