Systemic Risk on the Interbank Market
35 Pages Posted: 6 Feb 2001
Date Written: September 2004
We simulate interbank lending. Each bank faces fluctuations in liquid assets and stochastic investment opportunities which mature with delay. This creates the risk of liquidity shortages. An interbank market lets participants pool this risk but also creates the potential for one bank's crisis to propagate through the system. We study banking systems with homogeneous banks, as well as systems in which banks are heterogeneous. With homogeneous banks, an interbank market unambiguously stabilizes the system. With heterogeneity, knock-on effects become possible but the stabilizing role of interbank lending remains so that the interbank market can play an ambiguous role.
Keywords: Systemic risk, contagion, interbank lending
JEL Classification: E5, G21
Suggested Citation: Suggested Citation