Ten years after the 2008 financial crisis, the importance of the interconnectedness of the financial system for its stability has become widely recognized.
The architecture of financial networks matters because the indirect exposures of a financial institution, via its counterparties, can have comparable impact to its direct exposure to shocks on certain asset classes. Moreover, today we have a mathematical understanding of when and why risk diversification across counterparties and external assets can lead to higher systemic risk, instead of leading to higher financial stability. These fundamental insights from the discipline of financial networks contrast with traditional views that neglect the complexity of the interactions among financial institutions and the frictions that lead to shock amplification.
In the wake of Paris agreement and the growing societal concern on climate change, financial stability is seen today as a precondition for a broader policy agenda on sustainable finance, aiming at building a financial system that accounts for the social and environmental impact of institutions' financial portfolios. Understanding the direct and indirect exposure of public and private finance to climate change, both in terms of physical risks and energy transition risks, is a new emerging frontier of application for financial networks.