Liquidity, Interbank Network Topology and Bank Capital

Abstract

This paper utilizes interbank network simulation to investigate whether the relationship between capital and liquidity is influenced by bank positions in the interbank network. While previous literature has emphasized the causal relationship from liquidity to capital, the impact of interbank network characteristics on this relationship remains unclear. Drawing on a sample of commercial banks from 28 European countries, this study suggests that the interconnectedness of banks within interbank loan and deposit networks shapes their decisions to establish higher or lower regulatory capital ratios in the face of increased illiquidity. These findings support the implementation of minimum liquidity ratios alongside capital ratios, as advocated by the Basel Committee on Banking Regulation and Supervision. Additionally, the paper underscores the importance of regulatory authorities considering the network characteristics of banks in their oversight and decision-making processes.

Keywords: Interbank Network Topology, Bank Regulatory Capital, Liquidity Risk, Basel III

JEL Classification: G21, G28, L14