Systemic risk and hetetogeneous leverage in banking networks: Implications for banking regulation

In this paper, I study systemic risk implications of balance sheet heterogeneity in a banking network. More specifically, I analyse systemic impacts of financial leverage heterogeneity in a banking system under the existence of idiosyncratic shocks. It has been shown that, introducing leverage heterogeneity in the banking system strictly changes systemic risk measures and reveals the significance of bank spedicif characteristics. In the calibration, I have used the historical financial leverage data of the US banking system used in a recent stress testing exercise conducted by the FED. Through experiments, I have observed that relative systemic significance of the biggest and the most connected borrowers alters depending upon connectivity of network. The evolution of the network, systemic consequences of interbank market size and market segmentation are also analysed in case of idiosyncratic shocks with different target banks. Our study is also related to the recent BASEL III regulations on systemic risk and the treatment of the Global Systemically Important Banks (GSIB's). Our approach can be useful to assess to what extent the recent capital surcharges on GSIB's can be useful to curb the financial fragility in the banking system. I have shown that, applying surcharge for the most levered banks reduces the total systemic risk existing in the banking system.