Systemic risk in financial systems: A feedback approach

- The paper develops a model to estimate systemic risk that incorporates feedback effects.
- The feedback generates a micro-level financial accelerator.
- The model includes not only interbank activities but also loans to the real economy.
- We provide theoretical properties for the model.
- We validate the model using a unique dataset for the Brazilian economy.

We develop an innovative framework to estimate systemic risk that accounts for feedback effects between the real and financial sectors. We model the feedback effects through successive deterioration of borrowers' creditworthiness and illiquidity spreading, thus giving rise to a micro-level financial accelerator between firms and banks. We demonstrate that the model converges to a unique fixed point and the key role that centrality plays in shaping the level of amplification of shocks. We also provide a mathematical framework to explain systemic risk variations in time as a function of the network characteristics of economic agents. Finally, we supply empirical evidence on the economic significance of the feedback effects on comprehensive loan-level data of the Brazilian credit register. Our results corroborate the importance of incorporating new contagion channels besides the traditional interbank market in systemic risk models.