Bank Networks: Contagion, Systemic Risk and Prudential Policy

39 Pages Posted: 22 Dec 2016

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: December 2016

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 an assortative matching process. Contagion occurs through liquidity hoarding, interbank interlinkages and fire sale externalities. The resulting network configuration exhibits a core-periphery structure, disassortative behavior and low density. Within this framework we analyse the effects of a stylized set 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 also tend to reduce risk (hence increase stability), though without reducing significantly overall investment. On this basis, our results provide general support for the Basel III approach based on complementary regulatory metrics.

Keywords: Banking networks, systemic risk, contagion, fire sales, prudential regulation

JEL Classification: D85, G21, G28, C63, L14

Suggested Citation

Aldasoro, Iñaki and Delli Gatti, Domenico and Faia, Ester, Bank Networks: Contagion, Systemic Risk and Prudential Policy (December 2016). BIS Working Paper No. 597, Available at SSRN: https://ssrn.com/abstract=2888082

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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