The contagion effect and its mitigation in the modern banking system

Abstract

Purpose: The aim of this article is to identify which solutions reducing the contagion effect applied during the first global financial crisis in the 21st century may be treated as universal and as such – be also implemented during the crisis caused by the coronavirus pandemic. Design/Methodology/Approach: Literature analysis, the theoretical foundations of the contagion effect and the analysis of financial and historical data were used as the research method. Findings: The impact of the contagion effect on the course and scale of the financial crisis depends on many factors and circumstances, which differ in respect of a country and additionally change in time, in spite of the fact that the system of disorder impulse transmission is universal and includes four basic channels, namely liquidity (repo transactions and unsecured financing), assets and public debt channel. Practical Implications: The combination of administrative tools (e.g., introduction of a temporary ban on the short-term sale of shares listed on stock exchange) and central bank monetary policy instruments (e.g. practically unlimited access to liquidity for banks) may considerably reduce the role of the liquidity channel in the contagion effect transmission. Non-standard banking activity on the government securities markets led to the reduction of sovereign bonds margins, thus contributing to the limitation of contagion effect thought the public debt channel. Originality/Value: The article specifically indicated and evaluated the shock transmission channels and contagion effects between countries and markets and between banks through the interbank market (taking into account the differences and specific character of the secured and unsecured lending market). Also, operations and strategic methods for reducing the contagion effect were proposed.

Purpose: The aim of this article is to identify which solutions reducing the contagion effect applied during the first global financial crisis in the 21st century may be treated as universal and as such – be also implemented during the crisis caused by the coronavirus pandemic. Design/Methodology/Approach: Literature analysis, the theoretical foundations of the contagion effect and the analysis of financial and historical data were used as the research method. Findings: The impact of the contagion effect on the course and scale of the financial crisis depends on many factors and circumstances, which differ in respect of a country and additionally change in time, in spite of the fact that the system of disorder impulse transmission is universal and includes four basic channels, namely liquidity (repo transactions and unsecured financing), assets and public debt channel. Practical Implications: The combination of administrative tools (e.g., introduction of a temporary ban on the short-term sale of shares listed on stock exchange) and central bank monetary policy instruments (e.g. practically unlimited access to liquidity for banks) may considerably reduce the role of the liquidity channel in the contagion effect transmission. Non-standard banking activity on the government securities markets led to the reduction of sovereign bonds margins, thus contributing to the limitation of contagion effect thought the public debt channel. Originality/Value: The article specifically indicated and evaluated the shock transmission channels and contagion effects between countries and markets and between banks through the interbank market (taking into account the differences and specific character of the secured and unsecured lending market). Also, operations and strategic methods for reducing the contagion effect were proposed.