Failure and Rescue in an Interbank Network

33 Pages Posted: 25 Sep 2011

See all articles by L. C. G. Rogers

L. C. G. Rogers

University of Cambridge - Centre for Mathematical Sciences

Luitgard A. M. Veraart

London School of Economics & Political Science (LSE) - Department of Mathematics

Date Written: September 23, 2011

Abstract

This paper is concerned with systemic risk in the interbank market. We model this market as a directed graph in which the banks represent the nodes and the liabilities between the banks represent the edges. Our work builds on the modelling paradigm of Eisenberg and Noe (2001, Management Science, 47), extending it by introducing default costs in the system. We provide a rigorous analysis of those situations in which banks have incentives to bailout distressed banks. Such incentives exist under very mild conditions. We illustrate our results with some simple examples, and go on to discuss possible measures of soundness of a financial system, together with possible policy implications for resolution of distress.

Keywords: interbank network, systemic risk, bailout, bank mergers

JEL Classification: C69, G21, G33

Suggested Citation

Rogers, L. C. G. (Chris) and Veraart, Luitgard A. M., Failure and Rescue in an Interbank Network (September 23, 2011). Available at SSRN: https://ssrn.com/abstract=1932911 or http://dx.doi.org/10.2139/ssrn.1932911

L. C. G. (Chris) Rogers

University of Cambridge - Centre for Mathematical Sciences ( email )

Cambridge, CB3 9DD
United Kingdom

Luitgard A. M. Veraart (Contact Author)

London School of Economics & Political Science (LSE) - Department of Mathematics ( email )

Houghton Street
GB-London WC2A 2AE
United Kingdom

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