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An economic model of contagion in interbank lending markets

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  • Dan Ladley

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Abstract

This paper considers the stability of a financial system in which heterogenous banks interact through a lending market. We analyse a discrete time model in which households and banks are located on a circular city. Households present banks with risky investment opportunities, which banks fund through deposits and interbank borrowing. In the event of bankruptcy, a bank defaults on its interbank loans potentially resulting in contagion and losses for other banks. Through simulation we examine the vulnerability of the financial system to systemic events, demonstrating the non-linear relationship between market concentration, shock severity and bankruptcies. The role and effect of regulatory actions such as reserve requirements, minimum bank capitalisation and constraints on the size of borrowing relationships, are considered in limiting these effects.

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Bibliographic Info

Paper provided by Department of Economics, University of Leicester in its series Discussion Papers in Economics with number 11/06.

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Date of creation: Nov 2010
Date of revision: Dec 2010
Handle: RePEc:lec:leecon:11/06

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Postal: Department of Economics University of Leicester, University Road. Leicester. LE1 7RH. UK
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Keywords: Systemic risk; Interbank lending; Regulation; Network; Heterogeneity;

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Citations

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Cited by:
  1. Giulia Iori & Rosario N. Mantegna & Luca Marotta & Salvatore Micciche' & James Porter & Michele Tumminello, 2014. "Networked relationships in the e-MID Interbank market: A trading model with memory," Papers 1403.3638, arXiv.org.
  2. Laura Capera & Juan Sebastián Lemus & Dairo Estrada, . "Relaciones crediticias y riesgo de contagio en el mercado interbancario no colateralizado colombiano," Temas de Estabilidad Financiera, Banco de la Republica de Colombia 077, Banco de la Republica de Colombia.
  3. Christoffer Kok & Mattia Montagna, 2013. "Multi-layered Interbank Model for Assessing Systemic Risk," Kiel Working Papers 1873, Kiel Institute for the World Economy.
  4. Marc de Kamps & Daniel Ladley & Aistis Simaitis, 2012. "Heterogeneous Beliefs in Over-The-Counter Markets," Discussion Papers in Economics, Department of Economics, University of Leicester 13/03, Department of Economics, University of Leicester, revised Sep 2013.
  5. Augusto Hasman, 2013. "A Critical Review Of Contagion Risk In Banking," Journal of Economic Surveys, Wiley Blackwell, Wiley Blackwell, vol. 27(5), pages 978-995, December.
  6. Christoph Aymanns & Co-Pierre Georg, 2014. "Contagious Synchronization and Endogenous Network Formation in Financial Networks," Papers 1408.0440, arXiv.org.
  7. Fischer, Thomas & Riedler, Jesper, 2012. "Prices, debt and market structure in an agent-based model of the financial market," ZEW Discussion Papers, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research 12-045, ZEW - Zentrum für Europäische Wirtschaftsforschung / Center for European Economic Research.

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