Circular Leverage in Bank-NBFI Synthetic Risk Transfer Networks

Bilar, Daniyel Yaacov · 2026-08-18 · publication/preprint v2 · cc-by-4.0

Abstract

Synthetic Risk Transfers (SRTs) let banks shed credit risk to non-bank financial intermediaries while keeping the underlying loans on their balance sheets. A structural vulnerability arises when the same banks extend credit lines to the funds that buy their SRT protection, creating a circular leverage loop in which the capital relief is partly self-funded. We formalize this loop as a single parameter, λ, the fraction of total SRT protection weight financed by the originating bank or its affiliates. Using a directed network model of bank-NBFI SRT relationships, we simulate contagion cascades across 1,000 random network realizations for each λ value. The simulation shows a two-stage phase transition: cascade size first departs meaningfully from its baseline at λ_onset ≈ 0.85–0.95, then jumps sharply at λ* ≈ 0.95 where Dragon King events emerge from the loop mechanism itself. The transition location is invariant across network density, investor concentration, shock size, and tranche thickness; what density controls is cascade magnitude at high λ, which scales from 0.18 to 0.61 across the tested range. Because λ is not disclosed, we cannot place the real market on this phase diagram. Instead, we propose six publicly observable proxy metrics, computable without proprietary data, ranked by sensitivity-weighted ordinal position relative to λ*. As of Q2/Q3 2026, five of six proxy metrics show stress; SOFR–OIS remains green. A v2 re-run at the empirical median junior tranche thickness leaves λ* at 0.95. One number, λ, would let supervisors place banks on the phase diagram. It is already known to each originating bank and is not reported.

Keywords

synthetic risk transfer · circular leverage · network contagion · phase transition · Dragon King · LPPLS · private credit · systemic risk · NBFI · Basel III · Pillar 3 · AnaCredit

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