The paper entitled “Interbank Network Stability and Optimal Strategies to Deal with Systemic Risk: Based on the perspective of government shareholding”, which was written by our school’s Professor Wang Hui, PhD student Zhu Jiayun from the School of Finance of CUFE, and Assistant Researcher Chen Xu from the Financial Research Center of Chinese Academy of Fiscal Sciences, has been published in the 2021 11th issue of Economic Research Journal.
The financial crisis that broke out in 2008 have a huge impact on financial stability and economic development all over the world, making the systemic financial risk become the focus of the regulatory authorities and the academic community. Although China has not suffered a financial crisis in recent years, its financial system has experienced several shocks in recent years. With the increasing complexity of financial networks, risk events of small and medium-sized banks may evolve into systemic financial risks through contagion amplification mechanism, which calls people’s great attention. Compared with Western countries, the government shareholding proportion of China's banks is higher, and the state-owned financial institutions are a key pillar for serving the real economy, preventing financial risks, and deepening financial reform. Therefore, we study the prevention and resolution strategies of China's systemic risks from the perspective of government shareholding.
We innovatively quantify the bargaining power of government-controlled banks into premium multiples and introduces the premium multiples together with the autocorrelation of bank reserve price after the occurrence of liquidity shock into the transaction price formation mechanism among banks. Based on interbank balance sheet and equity structure data of 139 banks from 2017 to 2019, we estimate the core characteristics of the interbank lending network using exogenous maximum information entropy network, and construct the endogenous equilibrium transaction network (ETN) of China's interbank market. Based on the ETN, this paper quantifies the optimal range of bank correlation and the effects of various government bail-out policies from the two dimensions of transaction efficiency and stability of financial system, and gives the optimal coping strategies for systemic financial risks.
Our results show that: Firstly, in the interbank lending market, government shareholding causes a positive premium effect, making it easier for banks to borrow funds. Empirical analysis shows that this effect still exists after controlling for the factors of lending volume. The government-controlled banks have a positive premium of about 7% to 14% in the interbank market. When tight market liquidity leads to sharp price fluctuations, the premium multiple of the government-controlled banks increases significantly, and the increase rate of the premium multiple of the government-directly-controlled banks exceeds that of the government-indirectly- controlled banks. Secondly, implementing effective macro-prudential policies and moderately limiting the business correlation of financial institutions in advance, for example, setting the maximum interconnectedness limitation of 60 to 80, will not only avoid institutions being "too interconnected to fail", but also greatly affect the transaction efficiency and stability of the financial system. Thirdly, from the simulation analysis of risk disposal measures, it can be seen that under different situations, there are differences in rescue costs and policy effects of various bail-out methods. The change of market risk tolerance will determine the choice of government liquidity injection mode. Appropriate restrictions on the interconnectedness of banks before risk events can improve the effect of government bail-out policies. When the market panic occurs, the cost of rescuing systemically important banks on the verge of bankruptcy is huge, but the whole banking system can quickly recover stability. When market expectations are relatively positive, injecting capital into surviving government-controlled banks is the best strategy. Fourthly, when extreme risks occur in government-controlled banks and the "belief" of government guarantee is broken, the other banks will produce the phenomenon of " Reluctant to lend ". The failure of market liquidity creation will increase the cost of bail-out. The premium multiple will change and so should the optimal risk disposal strategy.
The findings of this study have three policy implications．Firstly, To prevent systemic financial risks, the government should optimize the layout of state-owned financial capital and maintain the government shareholding position in systemically important financial institutions. The government should also increase the proportion of government shareholding in important nodal financial institutions to continuously enhance the resilience of China's financial network. Secondly, the government can add limits on financial institutions' business interconnectedness to its macro-prudential policy toolbox to prevent the "too interconnected to fail" problem. Thirdly, China should strengthen the coordination and cooperation between fiscal and financial departments, and improve the systematic financial risk disposal strategy composed of macroprudential policies and government rescue policies.