Contagion Dynamics and Credit Risk Mitigation. The Role of the Network Arising from the Customers Cross - Relationships

In the credit risk context, the dynamics of contagion is extremely important: it represents the vehicle through which the problems of a firm may be transferred to the entire bank customers’ network, causing a chain of defaults. Data and Methods – As an example, we will study the resilience, under the failure of some nodes, of a network implicit in a unique data-set that includes the cross-relationships, during a five years period, among the firms that are customers of an Italian commercial bank. Results – The paper shows how the knowledge of the network’s structure, implicit in the relationships between a bank’s customer firms, can help a bank to understand whether, and to what extent, the difficulties of one firm can produce negative effects on the others via a contagion mechanism, and give useful information to assess the quality of the credit granting policy. Conclusions – The approach we propose can be useful not only for a bank’s financial decision making in the field of its customers bankruptcy prediction, credit scoring, correct quantification of credit risk and assessment of its credit granting policy, but also for regulation purposes with reference to the setting of capital requirements, the evaluation of systemic risk and the forecast of financial crisis and distress.