Can banks default overnight? Modeling endogenous contagion on O/N interbank market

28 Pages Posted: 21 Dec 2015 Last revised: 25 Mar 2016

See all articles by Paweł Smaga

Paweł Smaga

Warsaw School of Economics (SGH) - Department of Finance and Management; National Bank of Poland

Mateusz Wiliński

University of Warsaw - Faculty of Physics

Piotr Ochnicki

University of Warsaw - Faculty of Physics

Piotr Arendarski

Poznan University of Economics

Tomasz Gubiec

University of Warsaw - Faculty of Physics

Date Written: December 21, 2015

Abstract

We propose a new model of the liquidity driven banking system focusing on overnight interbank loans. This significant branch of the interbank market is commonly neglected in the banking system modeling and systemic risk analysis. We construct a model where banks are allowed to use both the interbank and the securities markets to manage their liquidity demand and supply as driven by prudential requirements in a volatile environment. The network of interbank loans is dynamic and simulated every day. We show how only the intrasystem cash fluctuations, without any external shocks, may lead to systemic defaults, what may be a symptom of the self-organized criticality of the system. We also analyze the impact of different prudential regulations and market conditions on the interbank market resilience. We confirm that central bank's asset purchase programs, limiting the declines in government bond prices, can successfully stabilize bank's liquidity demand. The model can be used to analyze the interbank market impact of macroprudential tools.

Keywords: contagion, interbank market, network analysis, systemic risk, quantitative easing, macroprudential policy

JEL Classification: F36, F42, G21, G28

Suggested Citation

Smaga, Paweł and Wiliński, Mateusz and Ochnicki, Piotr and Arendarski, Piotr and Gubiec, Tomasz, Can banks default overnight? Modeling endogenous contagion on O/N interbank market (December 21, 2015). Available at SSRN: https://ssrn.com/abstract=2706158

Paweł Smaga (Contact Author)

Warsaw School of Economics (SGH) - Department of Finance and Management ( email )

Warsaw
Poland

National Bank of Poland ( email )

Poland

Mateusz Wiliński

University of Warsaw - Faculty of Physics ( email )

Hoza 69
Warsaw, Pl-00681
Poland

Piotr Ochnicki

University of Warsaw - Faculty of Physics ( email )

Hoza 69
Warsaw, Pl-00681
Poland

Piotr Arendarski

Poznan University of Economics ( email )

Poznan, 60-967
Poland

Tomasz Gubiec

University of Warsaw - Faculty of Physics ( email )

Hoza 69
Warsaw, Pl-00681
Poland

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