Interconnectedness and systemic risk in financial networks: Fresh evidence from India

Abstract

Under a dynamic multivariate set-up with time-varying probabilities, we show that the Indian financial network exhibits a high degree of interconnectedness during crisis periods with banks as emitters and NBFCs as receivers of shocks. The structure of systemic risk is endogenous in nature due to the regulations and operational coverage. The dynamic interplay between systemic risk and network connectedness suggests that a sudden rise in systemic risk results in a significant increase in total connectedness, while a connectedness shock has a significant and short-term effect on systemic risk. At the institutional level, a shock to an institution's systemic risk contribution has a long-term impact on its net connectedness, while an unexpected rise in an institution's net connectedness has a persistent and decaying effect on its systemic risk contribution. The learnings are extremely helpful for regulators and banking sector investors.