The Schedule

28th April

Opening Remarks - Becky Maule (Head of Prudential Framework Division, Bank of England)

Eva Lütkebohmert-Holtz

Title: Name Concentration Risk in Multilateral Development Banks' Portfolios

(joint work with Julian Sester and Hongyi Shen)

Related paper: https://arxiv.org/abs/2311.13802,

https://arxiv.org/abs/2403.16525

Abstract: Sovereign loan portfolios of Multilateral Development Banks (MDBs) typically comprise a small number of borrowers, making them particularly exposed to single name concentration (SNC) risk. Using realistic MDB portfolios constructed from publicly available data, we quantify SNC risk through accurate Monte Carlo simulations. We find that SNC risk can account for up to 82% of total unexpected loss in MDB sovereign loan portfolios.  Comparing the exact adjustment for SNC risk with its analytical approximation currently applied by a major rating agency, we show that the approximation can overestimate SNC risk by up to 266%. This overestimation has implications for the assessment of MDB capital adequacy, potentially limiting MDB lending capacity. Our results suggest that adopting a more accurate assessment of SNC risk could increase lending capacity by approximately 5% without affecting risk-weighted capital ratios. These findings highlight the importance of refining capital adequacy methodologies to better reflect the unique risk profiles of MDBs and unlock additional lending headroom for global development.

We then suggest a new deep learning approach for the quantification of name concentration risk in loan portfolios. Our approach is tailored for small portfolios and allows for both an actuarial as well as a mark-to-market definition of loss. The training of our neural network relies on Monte Carlo simulations with importance sampling which we explicitly formulate for the CreditRisk+ and the ratings-based CreditMetrics model. Numerical results based on simulated as well as real data demonstrate the accuracy of our new approach and its superior performance compared to existing analytical methods for assessing name concentration risk in small and concentrated portfolios.

Rama Cont

Title:  Modelling sovereign debt: credit risk and sustainability analysis

Abstract: (Joint work with Karolina BASSA (Oxford)) We present an empirically grounded quantitative framework for modelling sovereign credit risk and evaluating the sustainability of sovereign debt. We study the impact of  fiscal and public investment policies on the sovereign's borrowing cost and credit risk in presence of stochastic output shocks and credit-sensitive funding from investors, with a focus on the dynamics of liquidity flows  and the sustainability of sovereign debt. Our model successfully replicates a range of empirical observations on sovereign credit risk and sovereign defaults.

In particular, it reproduces Argentina’s 2001 default and Greece’s 2011 debt restructuring events and leads to realistic dynamics for debt, spreads and credit ratings conditional on output.

The framework is useful for debt sustainability analysis and may be used to estimate the impact of fiscal policy on debt and output.

Virginia Puglies 

Title: X marks the bank: digitalisation and depositor run

Related paper: https://papers.ssrn.com/sol3/papers.cfm?abstract_id=5231564

Abstract: (join work with Artur Kotlicki and Purba Das)This paper examines how digitalisation amplifies liquidity pressures on banks during periods of financial stress, emphasising the role of social media in triggering unprecedented outflows in both size and speed, as witnessed during the March 2023 banking turmoil. To address this issue, we introduce a game-theoretic model where depositors’ decisions are shaped by common information sources and the exchange of sentiments through social media networks. Our model bridges the global games framework---characterised by fully disconnected agents with private signals---and the classical Diamond and Dybvig (1983) setting with perfect information, which emerges as a limiting case under full connectivity. We highlight the critical role of depositor concentration and behavioural correlation in determining the likelihood and timing of withdrawals. The model also introduces two novel measures, UncertRisk and CorrRisk, which quantify uncertainty and correlation risks in modern banking environments. Finally, we assess the effectiveness of various policy interventions aimed at addressing the vulnerabilities associated with digitalisation and modern depositor behaviour.

Luitgard A. M. Veraart

Title: Modelling contagious bank runs

Related paper: https://ssrn.com/abstract=5176815 

Abstract: We develop a modelling framework for contagion in financial networks arising from bank runs. We show how interacting channels of contagion, namely funding withdrawals in the interbank network and price-mediated contagion arising from fire sales can turn a bank run on one institution into a systemic crisis. Furthermore, we also model how contagion effects can lead to additional bank runs. Our model allows for a wide range of withdrawal mechanisms both by banks and by external depositors.  It can be used for financial stress testing and particularly for analysing implications of different withdrawal mechanisms for systemic risk. We illustrate this in stylised examples and an empirical case study. We find that the extent of systemic risk is highly sensitive to the choices of withdrawal strategies used by the market participants. We also discuss policy implications. 

Rustam Jamilov

Title: Two Centuries of Systemic Bank Runs

Abstract: We study bank runs using a novel historical cross-country dataset that covers 184 countries since 1800 and combines a new narrative chronology with statistical indicators of bank deposit withdrawals. We document the following facts: (i) the unconditional likelihood of a bank run is 1.9% and that of significant deposit withdrawals is 12.5% (ii) systemic bank runs-those that are accompanied by deposit withdrawals-are associated with substantially larger output losses than non-systemic runs or deposit contractions alone; (iii) bank runs are contractionary even when they are not triggered by fundamental causes, banks are well-capitalized, and there is no evidence of a crisis or widespread failures in the banking sector; (iv) in both historical and contemporary episodes, depositors tend to run on highly leveraged banks, which leads to a credit crunch and a reallocation of deposits across banks; and (v) liability guarantees are associated with lower output losses after systemic runs, while having a lender of last resort or deposit insurance reduces the probability of a run becoming systemic. Overall, our findings highlight a key role of sudden bank liability disruptions in economic fluctuations, over and above other sources of financial fragility.