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Resilience of the Interbank Network to Shocks and Optimal Bail-Out Strategy: Advantages of "Tiered" Banking Systems

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    Abstract

    This paper studies systemic risk and the scale of systemic breakdown in the frequently observed tiered banking system. The banking network is constructed from a number of banks which are linked by interbank exposures with a certain predefined probability. In this framework, the tiered structure is represented either by a network with negative correlation in connectivity of neighboring banks, or alternatively, by a network with a scale-free distribution of connectivity. The main findings of the paper highlight the advantages of tiering in terms of both the resilience of the banking network to systemic shocks and the extent of necessary government intervention should a crisis evolve.

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    File URL: http://homepage.univie.ac.at/Papers.Econ/RePEc/vie/viennp/vie1007.pdf
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    Paper provided by University of Vienna, Department of Economics in its series Vienna Economics Papers with number 1007.

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    Date of creation: Feb 2010
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    Handle: RePEc:vie:viennp:1007

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    Web page: http://www.univie.ac.at/vwl

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    1. 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.
    2. Nier, Erlend & Yang, Jing & Yorulmazer, Tanju & Alentorn, Amadeo, 2008. "Network models and financial stability," Bank of England working papers 346, Bank of England.
    3. Helmut Elsinger & Alfred Lehar & Martin Summer, 2002. "Risk Assessment for Banking Systems," Working Papers 79, Oesterreichische Nationalbank (Austrian Central Bank).
    4. Upper, Christian & Worms, Andreas, 2002. "Estimating Bilateral Exposures in the German Interbank Market: Is there a Danger of Contagion?," Discussion Paper Series 1: Economic Studies 2002,09, Deutsche Bundesbank, Research Centre.
    5. Sandro Brusco & Fabio Castiglionesi, 2005. "Liquidity Coinsurance, Moral Hazard and Financial Contagion," Department of Economics Working Papers 05-12, Stony Brook University, Department of Economics.
    6. 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.
    7. Andrea Galeotti & Sanjeev Goyal, 2009. "Influencing the influencers: a theory of strategic diffusion," RAND Journal of Economics, RAND Corporation, vol. 40(3), pages 509-532.
    8. Michael Boss & Martin Summer & Stefan Thurner, 2004. "Contagion Flow Through Banking Networks," Papers cond-mat/0403167, arXiv.org.
    9. Degryse, H.A. & Nguyen, G., 2006. "Interbank Exposures: An Empirical Examination of Contagion Risk in the Belgian Banking System," Discussion Paper 2006-016, Tilburg University, Tilburg Law and Economic Center.
    10. Acharya, Viral V & Yorulmazer, Tanju, 2005. "Cash-in-the-Market Pricing and Optimal Bank Bailout Policy," CEPR Discussion Papers 5154, C.E.P.R. Discussion Papers.
    11. Castiglionesi, F. & Navarro, N., 2007. "Optimal Fragile Financial Networks," Discussion Paper 2007-100, Tilburg University, Center for Economic Research.
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