Bank Networks: Contagion, Systemic Risk and Prudential Policy

40 Pages Posted: 13 Apr 2015

See all articles by Iñaki Aldasoro

Iñaki Aldasoro

Bank for International Settlements (BIS)

Domenico Delli Gatti

Università Cattolica del Sacro Cuore

Ester Faia

Goethe University Frankfurt; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 4 versions of this paper

Date Written: April 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 core-periphery 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 increasestability) without reducing significantly overall investment.

Keywords: banking networks, contagion, fire sales, prudential regulation, systemic risk

JEL Classification: C63, D85, G21, G28, L14

Suggested Citation

Aldasoro, Iñaki and Delli Gatti, Domenico and Faia, Ester, Bank Networks: Contagion, Systemic Risk and Prudential Policy (April 2015). CEPR Discussion Paper No. DP10540, Available at SSRN: https://ssrn.com/abstract=2593823

Iñaki Aldasoro (Contact Author)

Bank for International Settlements (BIS) ( email )

Centralbahnplatz 2
Basel, Basel-Stadt 4002
Switzerland

Domenico Delli Gatti

Università Cattolica del Sacro Cuore ( email )

LArgo Gemelli 1
Milan, 20123
Italy

Ester Faia

Goethe University Frankfurt ( email )

Grüneburgplatz 1
Frankfurt am Main, 60323
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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