## Interconnectedness, Systemic Crises and Recessions

_IMF Working Papers, February 27, 2015_

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## Bibliographic details
- Authors: Marco A Espinosa-Vega, Steven Russell
- Published: February 27, 2015
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781498386029.001

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### Model overview
- Objective: Capture and integrate four widely held views about financial crises.
- Core elements:
  - Banks make decisions about initiating and liquidating risky loans.
  - Interconnectedness among banks’ asset portfolios can obscure information about portfolio quality.
  - Lack of information about the quality of bank portfolios affects crisis dynamics.
  - Loss of confidence in the financial system influences the length and severity of recessions.

### Key findings and mechanisms
- Four foundational views captured:
  - [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.
- Mechanisms identified:
  - Interconnectedness can obscure information about asset portfolios, causing inefficient decisions about liquidation.
  - Obscured information affects decisions about retention of managers who assess credit risk, reducing future risk-assessment effectiveness.
  - Inefficient liquidation and impaired risk assessment can increase the depth of recessions and produce systemic financial crises.
  - These dynamics can increase the probability of lengthy, severe recessions.

### Policy implications and recommendations
- Government objective: Act in the interest of current and future depositors.
- Policy lever: Increase transparency of bank portfolios by limiting interconnectedness.
- Optimal regulation considerations:
  - The optimal degree of regulation may depend on depositors’ degree of risk aversion.
  - Even optimal regulation may not eliminate financial crises.

### Publication and metadata
- Authors: Marco A Espinosa-Vega, Steven Russell
- Date: February 27, 2015
- Series: IMF Working Papers
- Working Paper No.: 2015/046
- Issue: 046
- Volume: 2015
- Pages: 48
- DOI: https://doi.org/10.5089/9781498386029.001
- Stock No: WPIEA2015046
- ISBN: 9781498386029
- ISSN: 1018-5941
- Subjects: 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

*Source: IMF Working Paper "Interconnectedness, Systemic Crises and Recessions" (2015) by Marco A Espinosa-Vega and Steven Russell.*

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_Source: https://www.imf.org/en/publications/wp/issues/2016/12/31/interconnectedness-systemic-crises-and-recessions-42747_