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Criticality in a model of banking crises

  • Iori, Giulia
  • Jafarey, Saqib

An interbank market lets participants pool the risk arising from the combination of illiquid investments and random withdrawals by depositors. But it also creates the potential for one bank's failure to trigger off avalanches of further failures. We simulate a model of interbank lending to study the interplay of these two effects. We show that when banks are similar in size and exposure to risk, avalanche effects are small so that widening the interbank market leads to more stability. But as heterogeneity increases, avalanche effects become more important. By varying the heterogeneity and connectivity across banks, the system enters a critical regime with a power law distribution of avalanche sizes.

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Article provided by Elsevier in its journal Physica A: Statistical Mechanics and its Applications.

Volume (Year): 299 (2001)
Issue (Month): 1 ()
Pages: 205-212

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Handle: RePEc:eee:phsmap:v:299:y:2001:i:1:p:205-212
DOI: 10.1016/S0378-4371(01)00297-7
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  1. Charles W. Calomiris & Charles M. Kahn, 1996. "The Efficiency of Self-Regulated Payments Systems: Learning From the Suffolk System," NBER Working Papers 5442, National Bureau of Economic Research, Inc.
  2. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23.
  3. Rochet, Jean-Charles & Tirole, Jean, 1996. "Interbank Lending and Systemic Risk," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 28(4), pages 733-62, November.
  4. C. H. Furfine, 1999. "Interbank exposures: quantifying the risk of contagion," BIS Working Papers 70, Bank for International Settlements.
  5. Angelini, P. & Maresca, G. & Russo, D., 1996. "Systemic risk in the netting system," Journal of Banking & Finance, Elsevier, vol. 20(5), pages 853-868, June.
  6. Jacklin, Charles J & Bhattacharya, Sudipto, 1988. "Distinguishing Panics and Information-Based Bank Runs: Welfare and Policy Implications," Journal of Political Economy, University of Chicago Press, vol. 96(3), pages 568-92, June.
  7. Craig Furfine, 1999. "Interbank exposures: quantifying the risk of contagion," Proceedings 633, Federal Reserve Bank of Chicago.
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