Bank Networks: Contagion, Systemic Risk and Prudential Policy

SAFE Working Paper No. 87

43 Pages Posted: 3 Mar 2015 Last revised: 18 Jul 2015

See all articles by Iñaki Aldasoro

Iñaki Aldasoro

Bank for International Settlements (BIS)

Domenico Delli Gatti

Catholic University of Milan

Ester Faia

Goethe University Frankfurt

Multiple version iconThere are 4 versions of this paper

Date Written: July 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. Contagion occurs through liquidity hoarding, interbank interlinkages and fire sale externalities. The resulting network configuration exhibits a coreperiphery structure, dis-assortative behavior and low density. 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, 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 (July 2015). SAFE Working Paper No. 87, Available at SSRN: https://ssrn.com/abstract=2572877 or http://dx.doi.org/10.2139/ssrn.2572877

Iñaki Aldasoro

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Domenico Delli Gatti

Catholic University of Milan ( email )

Largo Gemelli 1
Milan, MI Milano 20123
Italy

Ester Faia (Contact Author)

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

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