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Contagion and risk-sharing on the inter-bank market

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  • Ladley, Daniel

Abstract

Increasing inter-bank lending has an ambiguous impact on financial stability. Using a computational model with endogenous bank behavior and interest rates we identify the conditions under which inter-bank lending promotes stability through risk sharing or provides a channel through which failures may spread. In response to large economy-wide shocks, more inter-bank lending relationships worsen systemic events. For smaller shocks the opposite effect is observed. As such no inter-bank market structure maximizes stability under all conditions. In contrast, deposit insurance costs are always reduced under greater numbers of inter-bank lending relationships. A range of regulations are considered to increase system stability.

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  • Ladley, Daniel, 2013. "Contagion and risk-sharing on the inter-bank market," Journal of Economic Dynamics and Control, Elsevier, vol. 37(7), pages 1384-1400.
    • Handle: RePEc:eee:dyncon:v:37:y:2013:i:7:p:1384-1400
    DOI: 10.1016/j.jedc.2013.03.009
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    More about this item

    Keywords

    Systemic risk; Inter-bank lending; Contagion; Regulation; Network;
    All these keywords.

    JEL classification:

    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques

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