The Rules of Contagion

split their activities. Because it was such a tough policy to get
through, it wasn’t picked up elsewhere; ring-fencing was proposed in
other parts of Europe, but not implemented.[95]
Ring-fencing isn’t the only strategy for reducing transmission.
When banks trade financial derivatives, it’s often done ‘over the
counter’ from one firm direct to another, rather than through a central
exchange. Such trading activity came to almost $600 trillion in 2018.
[96] However, since 2009, the largest derivatives contracts are no
longer traded directly between major banks. They now have to go
through independently run central hubs which have the effect of
simplifying the network structure.
The danger, of course, is that if a hub fails, it could become a giant
superspreader. ‘If there is a big shock, it makes things worse because
the risk is concentrated,’ said Barbara Casu, an economist at Cass
Business School.[97] ‘It should act as a risk buffer, but in extreme
cases it could act as a risk amplifier.’ To guard against this problem,
hubs have access to emergency capital from the members who use
them. This mutual approach has drawn criticism from financiers who
prefer an every-firm-for-themselves style of banking.[98] But by
removing the tangle of hidden loops from the network, the hubs
should mean fewer opportunities for contagion, and less uncertainty
about who is at risk.
Despite progress in our understanding of financial contagion, there
is still work to be done. ‘It’s like infectious disease modelling in the
1970s and 1980s,’ said Arinaminpathy. ‘There was a lot of great
theory and the data had some catching up to do.’ One of the big
obstacles is access to trading information. Banks are naturally
protective of their business activities, making it difficult for
researchers to form a picture of exactly how institutions are
connected, particularly at the global level. This makes it difficult to
assess potential contagion. Network scientists have found that, when
examining the probability of a crisis, small errors in knowledge about
the lending network could lead to big errors in estimates of system-
wide risk.[99]
Yet it’s not only a matter of trading data. As well as studying the
structure of networks, we need to think more about Newton’s