Banking systems simulation : theory, practice, and application of modeling shocks, losses, and contagion

259 Pages·2018·3.651 MB·English

by  Zedda, Stefano

BankingSystemsSimulation
Wiley Series in Modeling and Simulation
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Banking Systems Simulation
Theory, Practice, and Application of
Modeling Shocks, Losses, and Contagion
Stefano Zedda
University of Cagliari
Cagliari, Italy
Thiseditionfirstpublished2017
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10 9 8 7 6 5 4 3 2 1
The book “BANKING SYSTEMS SIMULATION” intuitively
presents essentials tools for integrating risks in banks and bank
systems that are essential for risk professionals and regulators.
Prof. Harald Scheule,
University of Technology Sydney,
Australia
StefanoZeddasucceedsinillustratingawidearrayofstateofthe
art techniques to set up effective models of bank management,
risks and contagion. Real life applications show how the book’s
key concepts can be used to overcome data limitations and
developparsimonious,yetaccuraterepresentationsofhowout­
side shocks and policy changes affect lenders.
Prof. Andrea Resti,
Università Bocconi,
Italy
The book offers a comprehensive analysis of bank and banking
system risks by adopting a simulation framework and an inte­
gratedapproachbetweenthemicroandmacrodimensionofrisk
management. The analysis provides important insights for aca­
demics, regulators and practitioners.
Prof. Francesco Vallascas,
University of Leeds,
UK

vii
Contents
Foreword xi
Introduction xv
1 Banking Risk 1
1.1 Single Bank Risk 4
1.2 The Basel Committee on Banking Supervision
Approach to Regulation 14
1.2.1 The Basel I Framework 16
1.2.2 The Basel II Framework 18
1.2.3 Credit Counterparty Risk 20
1.2.4 Market Risk 25
1.2.5 Operational Risk 28
1.2.6 Basel III 30
1.3 Banking Risk Modeling and Stress Testing 33
1.4 Contagion 36
1.5 System Modeling 41
2 Simulation Models 45
2.1 Simulating Shocks: Idiosyncratic Shocks, or Exogenous
Failure of Individual Banks 49
2.2 Simulating Shocks: Stress Testing 54
2.3 Simulating Shocks: Systematic Common Shocks 56
2.4 Simulating Shocks: Common Shocks 58
2.4.1 The Monte Carlo Method 59
2.4.2 Monte Carlo-Based Simulation Models 63
viii Contents
2.5 Estimation of Losses Variability and Assets
Riskiness 70
2.5.1 Sector-Historical Approach 71
2.5.2 Market Values-Based Approach 72
2.5.3 Capital Requirements-Based Approach 76
2.5.4 Ratings-Based Approach 79
2.5.5 CAMELS—Z-Score Approach 80
2.6 Simulating Shocks: Correlated Risk Factors 82
2.7 Simulating Shocks: Combining Idiosyncratic and
Common Shocks 87
2.8 Correlation 89
2.9 The Interbank Matrix 98
2.9.1 Interbank Matrix Estimation 110
2.9.2 Robustness Checks on the Maximum Entropy
Hypothesis 119
2.10 Loss Given Default 127
2.10.1 Constant LGD 128
2.10.2 Stochastic LGD 129
2.10.3 Endogenous LGD 130
2.11 Interbank Losses Attribution 132
2.12 Contagion Simulation Methods 133
2.13 Data and Applied Problems 140
3 Real Economy, Sovereign Risk, and Banking Systems
Linkages 149
3.1 Effects of Bank Riskiness on Sovereign Risk 150
3.2 Effects of Sovereign Risk on Bank Riskiness 153
3.3 Linkages to the Real Economy 154
3.4 Modeling 156
3.4.1 Banks 156
3.4.2 Public Finances 158
3.5 Implementation 159
3.5.1 Public Finances 159
3.5.2 Banks 160
4 Applications 163
4.1 Testing for Banks–Public Finances Contagion
Risk 163
Contents ix
4.2 Banking Systems Regulation What-If Tests 164
4.3 Banks’ Minimum Capital Requirements: Cost–Benefit
Analysis 169
4.3.1 Costs 170
4.3.2 Benefits 172
4.4 Deposits Guarantee Schemes (DGS)/Resolution Funds
Dimensioning 174
4.4.1 DGS 174
4.4.2 Resolution Funds 178
4.5 Computing Capital Coverage from Assets PD and
Bank PD 178
4.6 Computing Banks Probability to Default from Capital
Coverage and Assets PD 180
4.7 Risk Contributions and SiFis 182
4.7.1 Value at Risk (VaR) 183
4.7.2 Expected Shortfall (ES) 185
4.7.3 Conditional Value at Risk (CoVaR) 186
4.7.4 Marginal Expected Shortfall (MES) 189
4.7.5 Shapley Values 191
4.7.6 The Leave-One-Out Approach 193
4.7.7 Starting and Fueling Contagion: Risk Contribution
Roles 199
4.8 The Regulator’s Dilemma 202
Appendix: Software References and Tools 205
References 223
Index 235