Cross-Border Exposures and Financial Contagion

Integrated financial markets provide opportunities for expansion and improved risk sharing, but also pose threats of contagion risk through cross-border exposures. This paper examines cross-border contagion risk over the period 1999-2006. To that purpose we use aggregate cross-border exposures of seventeen countries as reported in the BIS Consolidated Banking Statistics. We find that a shock which affects the liabilities of one country may undermine the stability of the entire financial system. Particularly, a shock wiping out 25% (35%) of US (UK) cross-border liabilities against non-US (non-UK) banks could lead to bank contagion eroding at least 94% (45%) of the recipient countries’ banking assets. We also find that since 2006 a shock to Eastern Europe, Turkey and Russia affects most countries. Our simulations also reveal that the “speed of propagation of contagion” has increased in recent years resulting in a higher number of directly exposed banking systems. Finally we find that contagion is more widespread in geographical proximities.