Contagion accounting

We provide a simple and tractable accounting-based stress-testing framework to assess loss dynamics in the banking sector, in a context of leverage targeting. Contagion can occur through direct interbank exposures, and indirect exposures due to overlapping portfolios with the associated price dynamics via fire sales. We apply the framework to three granular proprietary ECB data sets, including an interbank network of 26 large euro-area banks as well as their overlapping portfolios of loans, derivatives and securities. A five per cent shock to the price of assets held in the trading book leads to an initial loss of 30 per cent of system equity and an additional loss of 1.3 per cent due to fire sales spillovers. Direct interbank contagion is negligible in our analysis. Our findings underscore the importance of accurately estimating the price effects of fire sales.