Leslie Sheng, Board of Governors of the Federal Reserve System
We dissect and quantify the evolving role of the global financial network in facilitating risk sharing and amplifying shocks using a structural model that incorporates both the global interbank network and the global bank-firm credit network. Our analysis yields five key results. (1) We provide estimates of cross-border interbank and bank-firm lending supply elasticity, and find that elasticities have significantly decreased since the global financial crisis (GFC). (2) The global financial network propagates local funding shocks through three margins of systemic rebalancing—global interbank rebalancing, global credit rebalancing, and self rebalancing. While the latter two margins mitigate a local funding shock in the origin country (providing “insurance”), interbank rebalancing can amplify the shock. (3) The insurance mechanism of systemic rebalancing has declined since the GFC, and global interbank rebalancing now amplifies shocks in most countries which it used to insure. (4) In the event of a simultaneous shock in many countries, the insurance mechanism breaks down. (5) We provide evidence that changes in regulation have contributed to the decline in insurance provided by the global financial network.