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Bank of Finland Research Discussion Papers, Bank of Finland

No 6/2009:
Financial interlinkages and risk of contagion in the Finnish interbank market

Mervi Toivanen ()

Abstract: Using the maximum entropy method, this paper estimates the danger of contagion in the Finnish interbank market in 20052007 as well as the existence of contagion during a Finnish banking crisis. The contagion analysis of the early 1990s is able to predict the most troublesome and defaulting banks in the banking sector. The simulation results for 20052007 suggest that five of ten deposit banks are possible starting points for contagious effects. The magnitude of contagion is conditional on the first failing bank. In addition to large commercial banks, middle-sized banks also cause damaging domino effects. Over the last few years, the negative effects of contagion on the Finnish banking sector have been, on average, more limited than those of the early 1990s. The contagion is currently a low probability event in the Finnish interbank market.

Keywords: contagion; interbank markets; Finland; maximum entropy; (follow links to similar papers)

JEL-Codes: G01; G21; (follow links to similar papers)

33 pages, January 28, 2009

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