Liquidity and Solvency Shocks in a Network Model of Systemic Risk: The Impact of Minimum Capital and Reserve Requirements

Abstract

We analyze the impact minimal capital and reserve requirements have on bank failures arising from solvency and liquidity shortages in a banking system where banks are characterized by the amount of capital, cash reserves and their exposure to the interbank loan market as borrowers as well as lenders. A network of interbank lending is established that is used as a transmission mechanism for the failure of banks through the system. We find that the impact of minimum capital and reserve requirements is small and excess holdings work to a similar degree, suggesting that targeting capital requirements more carefully on specific banks can be more eective than common minimum requirements for all banks.

Keywords: interbank loans, network topology, banking crises, bank failure, banking regulation