Interbank Runs: A Network Model of Systemic Liquidity Crunches

Abstract

This paper models systemic liquidity crunches on interbank lending networks, and studies how the network structure affects the instability. Interbank runs are modeled as a coordination failure, in which banks run on banks as they mutually reinforce each other to withdraw interbank lending. A mean-field approximation reduces the complex strategic interactions on networks down to a one-dimensional characterization of the system-wide dynamics. It explains how lending-borrowing relationships not only channel the "ripple'" effects of local shocks, but also connect the whole network into a self-fulfilling "tsunami". I demonstrate applications in network-based systemic risk measurement and management.

Keywords: Networks, Bank Runs, Interbank, Mean-field Approximation, Systemic Risk, Liquidity Crises

JEL Classification: G01, G20, D85