The effects of leverage requirements and fire sales on financial contagion via asset liquidation strategies in financial networks
-
Zachary Feinstein
and
Fatena El-Masri
Abstract
This paper provides a framework for modeling the financial system with multiple illiquid assets when liquidation of illiquid assets is caused by failure to meet a leverage requirement. This extends the network model of [6] which incorporates a single asset with fire sales and capital adequacy ratio. This also extends the network model of [14] which incorporates multiple illiquid assets with fire sales and no leverage ratios. We prove existence of equilibrium clearing payments and liquidation prices for a known liquidation strategy when leverage requirements are required. We also prove sufficient conditions for the existence of an equilibrium liquidation strategy with corresponding clearing payments and liquidation prices. Finally, we calibrate network models to asset and liability data for 50 banks in the United States from 2007–2014 in order to draw conclusions on systemic risk as a function of leverage requirements.
A Data
In Section 5 we utilize asset and liability data for 50 large financial institutions in the United States from 2007–2014. This data is broken down yearly into total assets and total liabilities. A subset of the collated data is presented in Table 3. The remainder of this section displays information on the leverage ratios for the financial institutions as a group. Histograms of the realized leverage ratios for each year are displayed in Figures 10–17. Figures 18–25 display the realized leverage ratios against total assets, liabilities, and equity for each firm as scatter plots. We do this to demonstrate, in general, that there is no discernible relation between firm size and realized leverage ratios. This can be used to justify our choice of a single leverage requirement for each firm in the case studies of Section 5 (as opposed to leverage requirements that depend on, e.g., initial firm size).
A sample of the data of assets and liabilities for US banks.
| Total assets | ||||||||
| Banks name | City | State | Parent name | TotAssets 2007 | TotAssets 2008 | TotAssets 2009 | TotAssets 2010 | TotAssets 2011 |
| JPMorgan Chase Bank, N.A. | Columbus | OH | JPMorgan Chase & Co. | 1,318,888,000 | 1,746,242,000 | 1,627,684,000 | 1,631,621,000 | 1,811,678,000 |
| Bank of America, N.A. | Charlotte | NC | Bank of America Corporation | 1,312,794,218 | 1,470,276,918 | 1,465,221,449 | 1,482,278,257 | 1,459,157,302 |
| Wells Fargo Bank, N.A. | Sioux Falls | SD | Wells Fargo & Company | 467,861,000 | 538,958,000 | 608,778,000 | 1,102,278,000 | 1,161,490,000 |
| Citibank, N.A. | Sioux Falls | SD | Citigroup Inc. | 1,251,715,000 | 1,227,040,000 | 1,161,361,000 | 1,154,293,000 | 1,288,658,000 |
| U.S. Bank National Association | Cincinnati | OH | U.S. Bancorp | 232,759,503 | 261,775,591 | 276,376,130 | 302,259,544 | 330,470,810 |
| PNC Bank, N.A. | Wilmington | DE | PNC Financial Services Group, Inc. | 124,782,289 | 140,777,455 | 260,309,849 | 256,638,747 | 263,309,559 |
| Bank of New York Mellon | New York | NY | Bank of New York Mellon Corporation | 115,672,000 | 195,164,000 | 164,275,000 | 181,792,000 | 256,205,000 |
| State Street Bank and Trust Company | Boston | MA | State Street Corporation | 134,001,964 | 171,227,778 | 153,740,526 | 155,528,576 | 212,292,942 |
| Capital One, N.A. | McLean | VA | Capital One Financial Corporation | 97,517,902 | 115,142,306 | 127,360,045 | 126,901,280 | 133,477,760 |
| TD Bank, N.A. | Wilmington | DE | Toronto-Dominion Bank | 45,485,973 | 101,632,075 | 140,038,551 | 168,748,912 | 188,912,554 |
| Total Liabilities | ||||||||
| Banks name | City | State | Parent name | TotLiab 2007 | TotLiab 2008 | TotLiab 2009 | TotLiab 2010 | TotLiab 2011 |
| JPMorgan Chase Bank, N.A. | Columbus | OH | JPMorgan Chase & Co. | 1,211,274,000 | 1,616,446,000 | 1,499,365,000 | 1,508,222,000 | 1,680,723,000 |
| Bank of America, N.A. | Charlotte | NC | Bank of America Corporation | 1,202,530,204 | 1,336,942,149 | 1,298,530,760 | 1,302,464,744 | 1,281,297,032 |
| Wells Fargo Bank, N.A. | Sioux Falls | SD | Wells Fargo & Company | 426,089,000 | 497,153,000 | 552,185,000 | 978,716,000 | 1,036,999,000 |
| Citibank, N.A. | Sioux Falls | SD | Citigroup Inc. | 1,151,143,000 | 1,144,600,000 | 1,043,468,000 | 1,026,333,000 | 1,136,309,000 |
| U.S. Bank National Association | Cincinnati | OH | U.S. Bancorp | 210,012,660 | 238,925,837 | 250,150,518 | 271,432,471 | 295,803,555 |
| PNC Bank, N.A. | Wilmington | DE | PNC Financial Services Group, Inc. | 109,846,056 | 127,862,023 | 228,481,932 | 222,888,583 | 227,956,188 |
| Bank of New York Mellon | New York | NY | Bank of New York Mellon Corporation | 106,543,000 | 183,441,000 | 150,538,000 | 165,927,000 | 237,946,000 |
| State Street Bank and Trust Company | Boston | MA | State Street Corporation | 122,060,508 | 157,881,228 | 139,072,508 | 138,831,760 | 193,568,478 |
| Capital One, N.A. | McLean | VA | Capital One Financial Corporation | 77,436,577 | 95,108,980 | 103,905,623 | 102,673,731 | 108,780,941 |
| TD Bank, N.A. | Wilmington | DE | Toronto-Dominion Bank | 35,794,451 | 83,340,196 | 117,537,086 | 142,907,066 | 161,094,419 |
A histogram of the leverage ratios from the initial data set on US banks in 2007.
A histogram of the leverage ratios from the initial data set on US banks in 2008.
A histogram of the leverage ratios from the initial data set on US banks in 2009.
A histogram of the leverage ratios from the initial data set on US banks in 2010.
A histogram of the leverage ratios from the initial data set on US banks in 2011.
A histogram of the leverage ratios from the initial data set on US banks in 2012.
A histogram of the leverage ratios from the initial data set on US banks in 2013.
A histogram of the leverage ratios from the initial data set on US banks in 2014.
A plot of leverage ratios as a function of assets, liabilities, and equity in 2007.
A plot of leverage ratios as a function of assets, liabilities, and equity in 2008.
A plot of leverage ratios as a function of assets, liabilities, and equity in 2009.
A plot of leverage ratios as a function of assets, liabilities, and equity in 2010.
A plot of leverage ratios as a function of assets, liabilities, and equity in 2011.
A plot of leverage ratios as a function of assets, liabilities, and equity in 2012.
A plot of leverage ratios as a function of assets, liabilities, and equity in 2013.
A plot of leverage ratios as a function of assets, liabilities, and equity in 2014.
Acknowledgements
Opinions expressed in this paper are those of the authors and not necessarily those of the FDIC. The authors are grateful to the editors and referees for their thoughtful comments and encouragements that led to this greatly improved paper.
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© 2017 Walter de Gruyter GmbH, Berlin/Boston
Articles in the same Issue
- Frontmatter
- Special Issue: Monitoring Systemic Risk: Data, Models and Metrics
- Network analysis and systemic FX settlement risk
- The effects of leverage requirements and fire sales on financial contagion via asset liquidation strategies in financial networks
- On the effect of heterogeneity on flocking behavior and systemic risk
Articles in the same Issue
- Frontmatter
- Special Issue: Monitoring Systemic Risk: Data, Models and Metrics
- Network analysis and systemic FX settlement risk
- The effects of leverage requirements and fire sales on financial contagion via asset liquidation strategies in financial networks
- On the effect of heterogeneity on flocking behavior and systemic risk
