Network Risk and Key Players: A Structural Analysis of Interbank Liquidity

Abstract

We estimate the liquidity multiplier and individual banks' contribution to systemic liquidity risk in an interbank network using a structural model. Banks borrow liquidity from neighbours and update their valuation based on neighbours' actions. When the former (latter) motive dominates, the equilibrium exhibits strategic substitution (complementarity) of liquidity holdings, and a reduced (increased) liquidity multiplier dampening (amplifying) shocks. Empirically, we find substantial and procyclical network-generated risks driven mostly by changes of equilibrium type rather than network topology. We identify the banks that generate most systemic risk and solve the planner's problem, providing guidance to macro-prudential policies.

Keywords: Liquidity, Interbank Market, Network, Systemic Risk, Strategic Complementarity, Amplification Mechanism