  It had been believed in the conventional practice that the risk of a bank
going bankrupt is lessened in a straightforward manner by transferring the risk
of loan defaults. But the failure of American International Group in 2008 posed
a more complex aspect of financial contagion. This study presents an extension
of the asset network systemic risk model (ANWSER) to investigate whether credit
default swaps mitigate or intensify the severity of financial contagion. A
protection buyer bank transfers the risk of every possible debtor bank default
to protection seller banks. The empirical distribution of the number of bank
bankruptcies is obtained with the extended model. Systemic capital buffer ratio
is calculated from the distribution. The ratio quantifies the effective loss
absorbency capability of the entire financial system to force back financial
contagion. The key finding is that the leverage ratio is a good estimate of a
systemic capital buffer ratio as the backstop of a financial system. The risk
transfer from small and medium banks to big banks in an interbank network does
not mitigate the severity of financial contagion.
