Bank Networks: Contagion, Systemic Risk and Prudential Policy

51 Pages Posted: 4 Feb 2015

See all articles by Iñaki Aldasoro

Iñaki Aldasoro

Bank for International Settlements (BIS)

Domenico Delli Gatti

Università Cattolica del Sacro Cuore

Ester Faia

Goethe University Frankfurt; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 4 versions of this paper

Date Written: January 30, 2015

Abstract

We present a network model of the interbank market in which optimizing risk averse banks lend to each other and invest in non-liquid assets. Market clearing takes place through a tâtonnement process which yields the equilibrium price, while traded quantities are determined by means of a matching algorithm. We compare three alternative matching algorithms: maximum entropy, closest matching and random matching. Contagion occurs through liquidity hoarding, interbank interlinkages and fire sale externalities. The resulting network configurations exhibits a core-periphery structure, dis-assortative behavior and low clustering coefficient. We measure systemic importance by means of network centrality and input-output metrics and the contribution of systemic risk by means of Shapley values. Within this framework we analyze the effects of prudential policies on the stability/efficiency trade-off. Liquidity requirements unequivocally decrease systemic risk but at the cost of lower efficiency (measured by aggregate investment in non-liquid assets); equity requirements tend to reduce risk (hence increase stability) without reducing significantly overall investment.

Keywords: banking networks, centrality metrics, systemic risk

JEL Classification: E430, E440, G110, G210, G280

Suggested Citation

Aldasoro, Iñaki and Delli Gatti, Domenico and Faia, Ester, Bank Networks: Contagion, Systemic Risk and Prudential Policy (January 30, 2015). CESifo Working Paper Series No. 5182, Available at SSRN: https://ssrn.com/abstract=2559722

Iñaki Aldasoro

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Domenico Delli Gatti (Contact Author)

Università Cattolica del Sacro Cuore ( email )

LArgo Gemelli 1
Milan, 20123
Italy

Ester Faia

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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