Externalities in interbank network: results from a dynamic simulation model
AbstractIn this paper we conduct a simulation run on a sample of Italian banks where a trigger shock, a one-off event fairly large in size, spreads through the interbank network in a set-up featuring among the actors both commercial banks and the authorities. The banks deleverage to comply with a regulatory capital (leverage) ratio, roll off interbank loans, bid for central bank liquidity, seek help within their own group and dispose of assets. As the shock spreads, borrowers who lack liquid assets may be forced to undertake fire sales, letting their capital position deteriorate. A vicious circle arises in which capital and liquidity risks amplify the crisis. When authorities intervene, unconventional monetary policies smooth the contagion over but these measures become less effective when the shock is very large, when the situation is best addressed by policies aiming at strengthening banksÂ’ capital. In a theoretical scenario, in which authorities do not enact specific measures, a small fraction of the banking system (in terms of total assets) may be in default at the end of the simulation, while a larger share of banks would need to be recapitalized.
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Bibliographic InfoPaper provided by Bank of Italy, Economic Research and International Relations Area in its series Temi di discussione (Economic working papers) with number 893.
Date of creation: Nov 2012
Date of revision:
banking crises; contagion; leverage; interbank market; central bank operations;
Find related papers by JEL classification:
- E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
- G01 - Financial Economics - - General - - - Financial Crises
- G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2012-12-22 (All new papers)
- NEP-BAN-2012-12-22 (Banking)
- NEP-CMP-2012-12-22 (Computational Economics)
- NEP-MAC-2012-12-22 (Macroeconomics)
- NEP-NET-2012-12-22 (Network Economics)
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Tobias Adrian & Hyun Song Shin, 2008.
"Liquidity and leverage,"
328, Federal Reserve Bank of New York.
- Mistrulli, Paolo Emilio, 2011.
"Assessing financial contagion in the interbank market: Maximum entropy versus observed interbank lending patterns,"
Journal of Banking & Finance,
Elsevier, vol. 35(5), pages 1114-1127, May.
- Paolo Emilio Mistrulli, 2007. "Assessing financial contagion in the interbank market: Maximum entropy versus observed interbank lending patterns," Temi di discussione (Economic working papers) 641, Bank of Italy, Economic Research and International Relations Area.
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