Interbank Runs: A Network Model of Systemic Liquidity Crunches

73 Pages Posted: 27 Jan 2018

See all articles by Yinan Su

Yinan Su

Johns Hopkins University - Carey Business School

Date Written: January 18, 2018

Abstract

I study how interbank lending network structures affect financial fragility. Interbank lending is beneficial but subject to coordination failure. With interbank wholesale funding, banks' balance sheets become inflated, and give the senior retail depositors a sense of safety to allow more illiquid assets. In interbank runs, banks run on banks as they mutually reinforce each other to withdraw interbank lending. Banks' individually precautionary liquidity hoarding strategies are connected by the pairwise lending relationships. Mean-field analysis extracts the systemic behavior from the network of strategic interactions. I show such dispersed and indirectly linked interactions also lead to discontinuous and system-wide liquidity crunches, as if the interactions are centralized. Local insolvency shocks trigger the interbank run if the network is unraveled beyond a critical point. The model is applied to identify the optimal capital injection targets of government bailouts, and study the systemic effects of the proposed regulations on restraining the highly connected banks.

Suggested Citation

Su, Yinan, Interbank Runs: A Network Model of Systemic Liquidity Crunches (January 18, 2018). Available at SSRN: https://ssrn.com/abstract=3104982 or http://dx.doi.org/10.2139/ssrn.3104982

Yinan Su (Contact Author)

Johns Hopkins University - Carey Business School ( email )

100 International Drive
Baltimore, MD 21202
United States

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