Monetary policy implementation in an interbank network: Effects on systemic risk
AbstractThis paper makes a conceptual contribution to the e ffect of monetary policy on financial stability. We develop a microfounded network model with endogenous network formation to analyze the impact of central banks' monetary policy interventions on systemic risk. Banks choose their portfolio, including their borrowing and lending decisions on the interbank market, to maximize profit subject to regulatory constraints in an asset-liability framework. Systemic risk arises in the form of multiple bank defaults driven by common shock exposure on asset markets, direct contagion via the interbank market, and firesale spirals. The central bank injects or withdraws liquidity on the interbank markets to achieve its desired interest rate target. A tension arises between the bene ficial effects of stabilized interest rates and increased loan volume and the detrimental effects of higher risk taking incentives.We fi nd that central bank supply of liquidity quite generally increases systemic risk. --
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Bibliographic InfoPaper provided by Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt in its series SAFE Working Paper Series with number 46.
Date of creation: 2014
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network formation; contagion; central banks' interventions;
Find related papers by JEL classification:
- C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
- D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
- G01 - Financial Economics - - General - - - Financial Crises
- G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
This paper has been announced in the following NEP Reports:
- NEP-ALL-2014-04-11 (All new papers)
- NEP-BAN-2014-04-11 (Banking)
- NEP-CBA-2014-04-11 (Central Banking)
- NEP-GER-2014-04-11 (German Papers)
- NEP-MON-2014-04-11 (Monetary Economics)
- NEP-NET-2014-04-11 (Network Economics)
- NEP-RMG-2014-04-11 (Risk Management)
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