Centrality-Based Capital Allocations

We look at the effect of capital rules on a banking system that is connected through correlated credit exposures and interbank lending. The rules, which combine individual bank characteristics and interconnectivity measures of interbank lending, are to minimize a measure of system-wide losses. Using the detailed German Credit Register for estimation, we find capital rules based on eigenvectors to dominate any other centrality measure, followed by closeness. Compared to the baseline case, capital reallocation based on the Adjacency Eigenvector saves 14.6% in system losses as measured by expected bankruptcy costs.

Keywords: Capital Requirements, Centrality Measures, Contagion, Financial Stability

JEL Classification: G21, G28, C15, C81

Suggested Citation: Suggested Citation

Alter, Adrian and Craig, Ben R. and Raupach, Peter, Centrality-Based Capital Allocations (2015). Bundesbank Discussion Paper No. 03/2015, Available at SSRN: https://ssrn.com/abstract=2797028 or http://dx.doi.org/10.2139/ssrn.2797028