Chapter 8. Systemic Bank Risk in Brazil: A Comprehensive Simulation of Correlated Market, Credit, Sovereign, and Interbank Risks
  • 1 0000000404811396https://isni.org/isni/0000000404811396International Monetary Fund

Abstract

In this study, we present a comprehensive forward-looking portfolio simulation methodology for assessing the correlated impacts of market risk, private sector and sovereign credit risk, and interbank default risk. In order to produce better integrated risk assessment for banks and systemic risk assessments for financial systems, we argue that reasonably detailed modeling of bank asset and liability structures, loan portfolio credit quality, and loan concentrations by sector, region, and type, as well as a number of financial and economic environment risk drivers, is required. Sovereign and interbank default risks are increasingly important in the current economic environment, and their inclusion is an important model extension. This extended model is demonstrated through an application to both individual Brazilian banks (i.e., 28 of the largest banks) and groups of banks (i.e., the Brazilian banking system) as of December 2004. Our results also show that a commonly used approach of aggregating all banks into one single bank for purposes of undertaking a systemic banking system risk assessment results in a misestimation of both the probability and cost of systemic banking system failures. Our analysis also indicates that, in the event of a sovereign default, the Government of Brazil would face constrained debt management alternatives. We conclude that such forward-looking risk assessment methodologies for assessing multiple correlated risks, combined with the targeted collection of specific types of data on bank portfolios, have the potential to better quantify overall bank and banking system risk levels, which can assist bank management, bank regulators, sovereigns, rating agencies, and investors to make better informed and proactive risk management and investment decisions.

Contributor Notes

This chapter was previously published as Barnhill and Souto (2009). The authors would like to thank Mathias Drehmann, Andrew Powell, Til Schuermann, and participants in the GEFRI Conference on Modeling and Managing Sovereign and Systemic Risk (Washington, 2006) and in the Conference on the Integration of Market and Credit Risk, sponsored by the Bank for International Settlements, the Bundesbank, and the Journal of Banking and Finance (Berlin, Integration of Market and Credit Risk, sponsored by the Bank for International Settlements, the Bundesbank, and the Journal of Banking and Finance (Berlin, chapter and suggested important areas for future work.
Author: Ms. Li L Ong