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Bank interconnectedness and financial stability: The role of bank capital

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  • Chen, Yehning

Abstract

This paper builds a network model to study the relation between financial stability and interconnectedness among banks. In the model, banks adopt a Value-at-Risk rule to determine capital ratios. It is shown that interconnectedness may hurt financial stability by amplifying the banks’ mistakes of underestimating risk, and that interconnectedness increases systemic risk. The results in the paper suggest that financial integration may hurt financial stability, and that bank interconnectedness is more harmful when the economy turns abruptly from boom to recession. In addition, banks should be given incentives to reduce interconnectedness if systemic risk is a serious concern for regulators.

Suggested Citation

  • Chen, Yehning, 2022. "Bank interconnectedness and financial stability: The role of bank capital," Journal of Financial Stability, Elsevier, vol. 61(C).
    • Handle: RePEc:eee:finsta:v:61:y:2022:i:c:s1572308922000432
    DOI: 10.1016/j.jfs.2022.101019
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    2. Michelangeli, Valentina & Piersanti, Fabio Massimo, 2023. "Interdependence between assets and liabilities in the banking system: Changes in the last two decades," Finance Research Letters, Elsevier, vol. 58(PA).

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    More about this item

    Keywords

    Financial network; Contagion; Interconnectedness; Diversification; Bank capital;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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