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Emergence of a Core-Periphery Structure in a Simple Dynamic Model of the Interbank Market

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  • Thomas Lux
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    Abstract

    This paper studies a simple dynamic model of interbank credit relationships. Starting from a given balance sheet structure of a banking system with a realistic distribution of bank sizes, the necessity of establishing interbank credit connections 3merges from idiosyncratic liquidity shocks. Banks initially choose potential trading partners randomly, but form preferential relationships via an elementary reinforcement learning algorithm. As it turns out, the dynamic evolution of this system displays a formation of a core-periphery structure with mainly the largest banks assuming the roles of money center banks mediating between the liquidity needs of many smaller banks. Statistical analysis shows that this evolving interbank market shares virtually all of the salient characteristics of interbank credit relationship that have been put forth in recent literature. Preferential interest rates for borrowers with strong attachment to a lender may prevent the system from becoming extortionary and guarantee the survival of the small peripherical banks

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    File URL: https://www.ifw-members.ifw-kiel.de/publications/emergence-of-a-core-periphery-structure-in-a-simple-dynamic-model-of-the-interbank-market-2/1917EmergenceofaCore-Periphery.pdf
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    Bibliographic Info

    Paper provided by Kiel Institute for the World Economy in its series Kiel Working Papers with number 1917.

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    Length: 25 pages
    Date of creation: Apr 2014
    Date of revision:
    Handle: RePEc:kie:kieliw:1917

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    Keywords: liquidity; interbank market; network formation;

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    1. Franziska Bremus & Claudia Buch & Katheryn Russ & Monika Schnitzer, 2013. "Big Banks and Macroeconomic Outcomes: Theory and Cross-Country Evidence of Granularity," NBER Working Papers 19093, National Bureau of Economic Research, Inc.
    2. Michael Boss & Helmut Elsinger & Martin Summer & Stefan Thurner, 2004. "Network topology of the interbank market," Quantitative Finance, Taylor & Francis Journals, vol. 4(6), pages 677-684.
    3. Kimmo Soramaki & Morten L. Bech & Jeffrey Arnold & Robert J. Glass & Walter Beyeler, 2006. "The topology of interbank payment flows," Staff Reports 243, Federal Reserve Bank of New York.
    4. Huberto M. Ennis, 2001. "On the size distribution of banks," Economic Quarterly, Federal Reserve Bank of Richmond, issue Fall, pages 1-25.
    5. Cocco, João F. & Gomes, Francisco J. & Martins, Nuno C., 2009. "Lending relationships in the interbank market," Journal of Financial Intermediation, Elsevier, vol. 18(1), pages 24-48, January.
    6. HyunSong Shin, 2009. "Securitisation and Financial Stability," Economic Journal, Royal Economic Society, vol. 119(536), pages 309-332, 03.
    7. Hałaj, Grzegorz & Kok, Christoffer, 2014. "Modeling emergence of the interbank networks," Working Paper Series 1646, European Central Bank.
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