{
  "title": "Modeling Correlated Systemic Liquidity and Solvency Risks in a Financial Environment with Incomplete Information",
  "publication": "IMF Working Papers, November 1, 2011",
  "sourceUrl": "https://www.imf.org/en/publications/wp/issues/2016/12/31/modeling-correlated-systemic-liquidity-and-solvency-risks-in-a-financial-environment-with-25356",
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  "summary": "This paper proposes and demonstrates a methodology for modeling correlated systemic solvency and liquidity risks for a banking system.",
  "sections": [
    {
      "heading": "Summary findings",
      "content": "- Proposes and demonstrates a methodology for modeling correlated systemic solvency and liquidity risks for a banking system using a forward looking simulation of many risk factors applied to detailed balance sheets for a 10 bank stylized United States banking system.\n- Estimates the probability that multiple banks will fail or experience liquidity runs simultaneously.\n- Significant systemic risk factors identified:\n  - financial and economic environment regime shifts to stressful conditions,\n  - poor initial loan credit quality,\n  - loan portfolio sector and regional concentrations,\n  - bank creditors' sensitivity to and uncertainties regarding solvency risk,\n  - inadequate capital.\n- Liquidity runs are modeled as a response to elevated solvency risk and uncertainties and are shown to increase correlated bank failures.\n- Potential bank funding outflows and contractions in lending with significant real economic impacts are estimated (no further numeric detail provided on the page).\n- Increases in equity capital levels needed to reduce bank solvency and liquidity risk levels to a target confidence level are estimated to range from 3 percent to 20 percent of assets.\n- For a future environment that replicates the 1987-2006 volatilities and correlations, the paper finds only a small risk of U.S. bank failures focused on thinly capitalized and regionally concentrated smaller banks.\n- For the 2007-2010 financial environment calibration the paper finds substantially elevated solvency and liquidity risks for all banks and the banking system."
    },
    {
      "heading": "Methodology",
      "content": "- Uses a forward looking simulation framework applying many risk factors to detailed bank balance sheets for a 10 bank stylized U.S. banking system.\n- Analyzes correlated market and credit risk, correlated defaults of borrowers, other market risks, and inter-bank defaults to drive systemic banking system solvency risk.\n- Models liquidity runs as endogenous responses by bank creditors to elevated solvency risk and to uncertainties about solvency, producing increased correlated failures."
    },
    {
      "heading": "Key quantitative results and scenarios",
      "content": "- Banking system modeled: 10 bank stylized United States banking system.\n- Equity capital increases to achieve target risk confidence: range from 3 percent to 20 percent of assets.\n- Historical environment calibrations discussed:\n  - 1987-2006 volatilities and correlations scenario: small risk of U.S. bank failures concentrated in thinly capitalized and regionally concentrated smaller banks.\n  - 2007-2010 financial environment calibration: substantially elevated solvency and liquidity risks for all banks and the banking system.\n- Publication specifics on the page: Pages: 49; Issue: 263; Series: Working Paper No. 2011/263; Volume: 2011; DOI: https://doi.org/10.5089/9781463924614.001; ISBN: 9781463924614; ISSN: 1018-5941."
    },
    {
      "heading": "Drivers of systemic solvency and liquidity risk (as identified)",
      "content": "- Correlated defaults of many borrowers.\n- Other market risks affecting asset values.\n- Inter-bank defaults and contagion.\n- Regime shifts to stressful financial and economic conditions.\n- Poor initial loan credit quality.\n- Loan portfolio sector and regional concentrations.\n- Creditor behavior: sensitivity to solvency risk and uncertainties that drive runs.\n- Inadequate equity capital buffers."
    },
    {
      "heading": "Policy implications and recommendations",
      "content": "- Strengthen equity capital buffers: estimated increases ranging from 3 percent to 20 percent of assets may be required to reduce solvency and liquidity risks to a target confidence level.\n- Monitor and mitigate concentration risks in loan portfolios by sector and region to reduce correlated borrower defaults.\n- Enhance supervision of loan credit quality and forward-looking stress testing under alternative environment calibrations (e.g., pre-2007 and 2007-2010 volatilities and correlations).\n- Incorporate creditor behavior and uncertainty-driven liquidity runs into systemic risk assessment and contingency planning.\n- Account for inter-bank exposures and potential contagion channels in systemic solvency and liquidity stress scenarios.\n\nModeling Correlated Systemic Liquidity and Solvency Risks in a Financial Environment with Incomplete Information — Miss Liliana B Schumacher, Theodore M. Barnhill (IMF Working Paper 2011/263).\n\n---\n\n Content in this bundle\n\n- wp11263\n  - wp11263 (Markdown version){rel=\"alternate\" type=\"text/markdown\"}\n  - wp11263 (PDF){rel=\"external\" type=\"application/pdf\"}\n\n---\n\nSource: https://www.imf.org/en/publications/wp/issues/2016/12/31/modeling-correlated-systemic-liquidity-and-solvency-risks-in-a-financial-environment-with-25356"
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    "Authors: Liliana B Schumacher, Theodore M. Barnhill",
    "Published: November 1, 2011",
    "Series: IMF Working Papers",
    "DOI: https://doi.org/10.5089/9781463924614.001",
    "Proposes and demonstrates a methodology for modeling correlated systemic solvency and liquidity risks for a banking system using a forward looking simulation of many risk factors applied to detailed balance sheets for a 10 bank stylized United States banking system.",
    "Estimates the probability that multiple banks will fail or experience liquidity runs simultaneously.",
    "Significant systemic risk factors identified:",
    "Liquidity runs are modeled as a response to elevated solvency risk and uncertainties and are shown to increase correlated bank failures.",
    "Potential bank funding outflows and contractions in lending with significant real economic impacts are estimated (no further numeric detail provided on the page).",
    "Increases in equity capital levels needed to reduce bank solvency and liquidity risk levels to a target confidence level are estimated to range from 3 percent to 20 percent of assets.",
    "For a future environment that replicates the 1987-2006 volatilities and correlations, the paper finds only a small risk of U.S. bank failures focused on thinly capitalized and regionally concentrated smaller banks.",
    "For the 2007-2010 financial environment calibration the paper finds substantially elevated solvency and liquidity risks for all banks and the banking system.",
    "Uses a forward looking simulation framework applying many risk factors to detailed bank balance sheets for a 10 bank stylized U.S. banking system.",
    "Analyzes correlated market and credit risk, correlated defaults of borrowers, other market risks, and inter-bank defaults to drive systemic banking system solvency risk.",
    "Models liquidity runs as endogenous responses by bank creditors to elevated solvency risk and to uncertainties about solvency, producing increased correlated failures.",
    "Banking system modeled: 10 bank stylized United States banking system.",
    "Equity capital increases to achieve target risk confidence: range from 3 percent to 20 percent of assets.",
    "Historical environment calibrations discussed:",
    "Publication specifics on the page: Pages: 49; Issue: 263; Series: Working Paper No. 2011/263; Volume: 2011; DOI: https://doi.org/10.5089/9781463924614.001; ISBN: 9781463924614; ISSN: 1018-5941.",
    "Correlated defaults of many borrowers.",
    "Other market risks affecting asset values.",
    "Inter-bank defaults and contagion.",
    "Regime shifts to stressful financial and economic conditions.",
    "Poor initial loan credit quality.",
    "Loan portfolio sector and regional concentrations.",
    "Creditor behavior: sensitivity to solvency risk and uncertainties that drive runs.",
    "Inadequate equity capital buffers.",
    "Strengthen equity capital buffers: estimated increases ranging from 3 percent to 20 percent of assets may be required to reduce solvency and liquidity risks to a target confidence level.",
    "Monitor and mitigate concentration risks in loan portfolios by sector and region to reduce correlated borrower defaults.",
    "Enhance supervision of loan credit quality and forward-looking stress testing under alternative environment calibrations (e.g., pre-2007 and 2007-2010 volatilities and correlations).",
    "Incorporate creditor behavior and uncertainty-driven liquidity runs into systemic risk assessment and contingency planning.",
    "Account for inter-bank exposures and potential contagion channels in systemic solvency and liquidity stress scenarios.",
    "**_wp11263**"
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