Efficiency-Stability Trade-Off in Financial Systems: A Multi-Objective Optimization Approach

13 Pages Posted: 14 Feb 2023

See all articles by Michel Alexandre

Michel Alexandre

Government of the Federative Republic of Brazil - Central Bank of Brazil

Thiago Silva

Government of the Federative Republic of Brazil - Central Bank of Brazil

Krzysztof Michalak

Wroclaw University of Economics and Business

Francisco Rodrigues

University of São Paulo (USP)

Abstract

In this paper, we address the efficiency-stability trade-off in the interbank (IB) market. The decision variable to be chosen by the financial regulator is the net worth-to-IB assets ratio assigned to each bank – the capital requirement (CR) – , aiming at minimizing both the fraction of IB assets lost as a consequence of an exogenous initial shock and the total net worth as a fraction of total IB assets. This framework is applied to a Brazilian data set considering two CR regimes: the homogeneous (same CR for all banks) and the heterogeneous regime (different CRs for each bank). The optimization in the heterogeneous regime is performed through a multi-objective optimization problem (MOP), solved through a multi-objective evolutionary algorithm based on decomposition (MOEA/D). We have found that the heterogeneous regime brings a Pareto gain over the homogeneous one: a smaller level of losses is achieved for the same aggregate CR. In the heterogeneous case, for each level of the initial shock, there is a critical value of aggregate CR below which financial crises become more frequent and more severe. Moreover, the decision variable assigned by different critical Pareto optimal points – i.e., those which generate values of CR close to its critical value – varies significantly. Finally, this variable is smaller and less dispersed for banks with a higher degree (i.e., those with more connections in the IB market, as well as a higher volume of IB assets and liabilities).

Keywords: financial stability, financial intermediation, systemic risk, interbank networks, multiobjectiveoptimization

Suggested Citation

Alexandre, Michel and Silva, Thiago and Michalak, Krzysztof and Rodrigues, Francisco, Efficiency-Stability Trade-Off in Financial Systems: A Multi-Objective Optimization Approach. Available at SSRN: https://ssrn.com/abstract=4357719 or http://dx.doi.org/10.2139/ssrn.4357719

Michel Alexandre (Contact Author)

Government of the Federative Republic of Brazil - Central Bank of Brazil ( email )

P.O. Box 08670
SBS Quadra 3 Bloco B - Edificio-Sede
Brasilia, Distr. Federal 70074-900
Brazil

Thiago Silva

Government of the Federative Republic of Brazil - Central Bank of Brazil ( email )

P.O. Box 08670
SBS Quadra 3 Bloco B - Edificio-Sede
Brasilia, Distr. Federal 70074-900
Brazil

Krzysztof Michalak

Wroclaw University of Economics and Business ( email )

Komandorska 118/120
Wrocław, 53-345
Poland

Francisco Rodrigues

University of São Paulo (USP) ( email )

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
16
Abstract Views
122
PlumX Metrics