Modeling Emergence of the Interbank Networks

41 Pages Posted: 15 Mar 2014

See all articles by Grzegorz Halaj

Grzegorz Halaj

National Bank of Poland

Christoffer Kok

European Central Bank (ECB)

Date Written: February 17, 2014

Abstract

Interbank contagion has become a buzzword in the aftermath of the financial crisis that led to a series of shocks to the interbank market and to periods of pronounced market disruptions. However, little is known about how interbank networks are formed and about their sensitivity to changes in key bank parameters (for example, induced by common exogenous shocks or by regulatory initiatives). This paper aims to shed light on these issues by modelling endogenously the formation of interbank networks, which in turn allows for checking the sensitivity of interbank network structures and hence their underlying contagion risk to changes in market-driven parameters as well as to changes in regulatory measures such as large exposures limits. The sequential network formation mechanism presented in the paper is based on a portfolio optimisation model whereby banks allocate their interbank exposures while balancing the return and risk of counterparty default risk and the placements are accepted taking into account funding diversification benefits. The model offers some interesting insights into how key parameters may affect interbank network structures and can be a valuable tool for analysing the impact of various regulatory policy measures relating to banks' incentives to operate in the interbank market.

Keywords: interbank network, financial contagion, counterparty risk, financial regulation

JEL Classification: G21, C63, C78

Suggested Citation

Halaj, Grzegorz and Kok, Christoffer, Modeling Emergence of the Interbank Networks (February 17, 2014). ECB Working Paper No. 1646. Available at SSRN: https://ssrn.com/abstract=2397106

Grzegorz Halaj (Contact Author)

National Bank of Poland ( email )

00-919 Warsaw
Poland

Christoffer Kok

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

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