Monetary Policy Implementation in an Interbank Network: Effects on Systemic Risk

Bluhm, Marcel; Faia, Ester; Krahnen, Jan Pieter

doi:10.2139/ssrn.2417219

Cited by 14 publications

(36 citation statements)

References 33 publications

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“…Bluhm et al (2014b) include the fire sales model of Cifuentes et al (2005) into a model with endogenous network formation. Bluhm et al (2014b) construct a dynamic network model with risk neutral, heterogeneous and micro-founded banks, whose links emerge endogenously from the interaction of intermediaries' optimizing decisions and an iterative tâtonnement process which determines market prices endogenously. The financial system featured in their model consists of a network with a finite number of financial institutions which solve an optimal portfolio problem, taking into account liquidity and capital constraints.…”

Section: Endogenous Network Formationmentioning

confidence: 99%

“…Banks choose the amount of interbank lending and/or borrowing by optimizing their (heterogeneous) balance sheets Bluhm et al, 2014b;Georg, 2013;Ha laj and Kok, 2015) and thereby create the structure of the interbank network. The literature on endogenous network formation combines economic modeling techniques with the insight that interconnections need to be taken seriously.…”

Section: Introductionmentioning

confidence: 99%

“…The third focus is on monetary policy. Central banks are introduced into the interbank network by allowing one bank either to supply an unlimited amount of liquidity (Bluhm et al, 2014b) or to provide liquidity against eligible collateral (Georg, 2013). The final and most studied area focuses on macro-prudential policy.…”

Section: Introductionmentioning

confidence: 99%

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Too interconnected to fail: a survey of the interbank networks literature

Hüser¹

2015

JNTF

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A network approach to banking is particularly important for assessing financial stability and systemic risk. This approach can be instrumental in capturing the externalities that the risk associated with a single institution may create for the entire system. Indeed, from a financial stability perspective, banks should neither be too-big-to-fail nor too-interconnected-to-fail. A better understanding of network externalities may facilitate the adoption of a macroprudential framework for financial supervision. Network externalities arise when risk-taking behavior of individual institutions affects other institutions and the system as a whole. To guide policy it becomes necessary, in this context, to measure the systemic importance of individual banks, i.e. their capacity to generate contagion in the rest of the system. The analysis of interbank networks can provide this guidance.Against this background we review the literature on interbank networks, which is part of a growing literature on financial networks. The broader financial networks literature is analyzing connections between financial institutions: banks, but also hedge funds, insurance companies, etc. We restrict the survey's focus on the interbank network literature. This survey presents a systematic overview of our current understanding of the structure of interbank networks, of how network characteristics affect contagion in the banking system and of how banks form connections when faced with the possibility of contagion and systemic risk. In particular, we highlight how the theoretical literature on interbank networks offers a coherent way of studying interconnections, contagion processes and systemic risk, while emphasizing at the same time the many challenges that must be addressed before general results on the link between the structure of the interbank network and financial stability can be established.The theoretical literature has generated a number of insights on the effect of the network structure on contagion. A first result is that the number and magnitude of defaults depend on the network topology. There is now substantial research characterizing those structures that tend to propagate default or alternatively that tend to dampen it. An avenue for further research is to have more realistic network structures on which to analyze contagion. Since empirical studies now provide an increasing number of stylized facts on the interbank network topology, research needs to move beyond deriving results on random networks or on overly simplified structures. Furthermore, the fragility of the system depends on the location in the network of the institution that was initially affected. Intuitively, the failure of core banks is more damaging than the failure of a periphery bank. Finally, another main finding is that there is a trade-off between risk sharing via linkages to other banks and contagion risk due to too many linkages. While the existence of the trade-off is not disputed, there is no consensus on whether a complete network dampens or fuels contag...

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Section: Endogenous Network Formationmentioning

confidence: 99%

Section: Introductionmentioning

confidence: 99%

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Too interconnected to fail: a survey of the interbank networks literature

Hüser¹

2015

JNTF

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“…As a second example, consider a bank which provides a new loan to the real economy. Unlike assumed in fractional reserve banking theories, 13 a bank 11 Further related analyses are carried out in Bluhm, Faia and Krahnen (2014b), and Aldasoro, Delli Gatti and Faia (2015).…”

Section: The Interbank Market As Insurance Mechanism For Persistent Lmentioning

confidence: 99%

“…9 See Georg (2013), Bluhm and Krahnen (2014), Bluhm, Faia and Krahnen (2014a), Bluhm, Faia and Krahnen (2014b) and Aldasoro, Delli Gatti and Faia (2015) for analyses of the financial system using agent based complex systems analysis.…”

Section: Introductionmentioning

confidence: 99%

Interbank Funding as Insurance Mechanism for (Persistent) Liquidity Shocks

Bluhm¹

2015

SSRN Journal

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Standard-Nutzungsbedingungen:Die Dokumente auf EconStor dürfen zu eigenen wissenschaftlichen Zwecken und zum Privatgebrauch gespeichert und kopiert werden.Sie dürfen die Dokumente nicht für öffentliche oder kommerzielle Zwecke vervielfältigen, öffentlich ausstellen, öffentlich zugänglich machen, vertreiben oder anderweitig nutzen.Sofern die Verfasser die Dokumente unter Open-Content-Lizenzen (insbesondere CC-Lizenzen) zur Verfügung gestellt haben sollten, gelten abweichend von diesen Nutzungsbedingungen die in der dort genannten Lizenz gewährten Nutzungsrechte. Terms of use: Documents in Non-Technical SummaryThe financial system serves to allocate funds from savers to investors. In this framework banks assume a crucial function via the provision of credit and liquidity to the real economy. To efficiently fulfill this function, the interbank market allows for the allocation of funds among banks. In particular, banks use the interbank market to hedge idiosyncratic liquidity shocks, that is, in-or outflow of funds. The recent financial crisis however has demonstrated that the interbank market can be prone to freezes and become a source of systemic risk and adverse spill-over effects to the banking system and the wider economy.This paper extends the literature on interbank markets via taking into account persistence of liquidity shocks. In particular, a theory of short and long term interbank funding is developed and embedded in a micro-founded agent based network model. The model combines analytical rigour with a flexible simulation framework in which effects driven by individually motivated heterogeneous agents on financial system and real economy can be assessed. Besides numerous innovations it features interbank funding as an over-the-counter phenomenon and realistically replicates financial system phenomena of network formation, monetary policy transmission and endogenous money creation. After investigating the model's network properties, it is used for analyses to shed light on the purpose of the interbank market and its role for allocation and stability in the financial system. Analyses in the modeling framework provide evidence that the interbank market renders the financial system more efficient relative to a setting without mutual insurance against persistent liquidity shocks. However, given that banks in the model can maximize profit via emitting credit and creating money while only facing limited liability, an unleashed financial system without a policymaker's regulation can well lead to economic outcomes below those resulting from a financial system with less efficient allocation. In a realistically calibrated simulation exercise featuring a policymaker who puts a lid on credit and money creation with a view on real economic activity while keeping financial fragility in check allows for significant output gains. Therefore the model provides evidence that interbank funding indeed plays a crucial role for welfare.Furthermore, and related to those findings, the framework is used to carry out an optimal po...

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Interbank borrowing and lending between financially constrained banks

Dietrich

Hauck

2019

Econ Theory

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Some stylized facts about transactions among banks are not easily reconciled with coinsurance of short-term liquidity risks. In our model, interbank markets play a different role. We argue that lending to another bank can reduce a bank's overall portfolio risk through diversification. If insolvency is costly, this diversification improves the interbank lender's funding liquidity, boosting credit supply to nonbanks. However, diversification comes at an endogenous cost that depends on bank-specific factors of interbank borrower and lender. The model provides a framework for understanding the importance of interbank lending for aggregate credit supply and the stability of banking systems. The model's predictions are consistent with evidence documented in the literature that other theories cannot consistently explain.

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Monetary Policy Implementation in an Interbank Network: Effects on Systemic Risk

Cited by 14 publications

References 33 publications

Too interconnected to fail: a survey of the interbank networks literature

Too interconnected to fail: a survey of the interbank networks literature

Interbank Funding as Insurance Mechanism for (Persistent) Liquidity Shocks

Interbank borrowing and lending between financially constrained banks

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