Bank Networks: Contagion, Systemic Risk and Prudential Policy

SAFE Working Paper No. 87

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

Iñaki Aldasoro

Bank for International Settlements (BIS); Goethe University Frankfurt; Goethe University Frankfurt - Research Center SAFE

Domenico Delli Gatti

Universita' Cattolica, Milano

Ester Faia

Goethe University Frankfurt; Kiel Institute for the World Economy; French National Center for Scientific Research (CNRS) - Centre d'Etudes Prospectives d'Economie Mathematique Appliquees a la Planification (CEPREMAP)

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

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Goethe University Frankfurt - Research Center SAFE ( email )

(http://www.safe-frankfurt.de)
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Domenico Delli Gatti

Universita' Cattolica, Milano ( email )

20123 Milano
Italy
+39 02 72342499 (Phone)
+39 02 72342923 (Fax)

Ester Faia (Contact Author)

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Kiel Institute for the World Economy

P.O. Box 4309
Kiel, D-24100
Germany

French National Center for Scientific Research (CNRS) - Centre d'Etudes Prospectives d'Economie Mathematique Appliquees a la Planification (CEPREMAP)

Ecole Normale Superieure
48 boulevard Jourdan
75014 Paris
France

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