Unraveling Double Shocks: An In-Depth Analysis of Risk Contagion in China's Inter-Bank Market

In an era marked by intricate financial networks and evolving market dynamics, this research delves into the labyrinth of risk contagion in China's inter-bank market to enhance financial stability. Focusing on the double shocks of counterparty breach and liquidity crisis, we scrutinize the systemic vulnerabilities and financial implications for both systemically and non-systemically important banks. Our study employs a comprehensive simulation approach, utilizing data from 157 banks in 2021, covering most Chinese provinces and representing approximately 80% of the nation's banking assets. The analysis encompasses the construction of long- and short-term inter-bank market matrices, providing insights into network topology and the identification of systemically important institutions. We map risk contagion hotspots across China's provinces by dividing the inter-bank market by province and visualizing transaction patterns. Our findings reveal that systemically important banks are more susceptible to financial stress and risk contagion under double shocks, resulting in heightened liquidity pressure, default risks, and capital losses. Moreover, our novel methodology of balance sheet re-scaling highlights the significance of regulatory metrics, emphasizing the importance of the loan-to-deposit ratio and leverage ratio in mitigating risk contagion effects. By striking a balance among key supervisory metrics, regulators and bank managers can bolster risk resilience and fortify the inter-bank market against the perils of double shocks. Our study serves as a reference point for regional risk management strategies and contributes to a deeper understanding of inter-bank risk contagion dynamics in the face of double shocks.