How vulnerable are interconnected portfolios of South African banks?

Abstract

Price shocks that propagate through the financial system present a significant risk to financial system stability. This study was an evaluation of the vulnerability of South African banks’ portfolios to pricemediated contagion in the last decade. Using longitudinal data of balance sheet positions of the 10 largest banks from 2010 to 2020, the stress tests were triggered by price shocks on one marketable asset held by all banks: South African government bonds. Overall, the study found that second-order feedback effects from bank deleveraging are muted and that the concentrated structure of the South African banking system has a positive effect on shock absorption. However, a gradual trend towards more similar asset portfolios in the past 10 years has gradually increased exposure to the price-mediated contagion channel. Significance: • The paper presents a novel modelling framework to study feedback price-effects in stress tests conducted on the South African banking system. • A new data set shows the evolution of South African banks’ portfolio structure and vulnerability by computing two fragility metrics and a portfolio similarity measure. • Using this data set, the relationship between banking sector vulnerability and portfolio similarity is tested empirically and it is shown how common asset holdings aggravate systemic risk to pricemediated contagion.

Keywords

• stress testing
• portfolio similarity
• fire-sale contagion