Systemic Losses Due to Counter Party Risk in a Stylized Banking System
We report a study of a stylized banking cascade model investigating systemic risk caused by counter party failure using liabilities and assets to define banks' balance sheet. In our stylized system, banks can be in two states: normally operating or distressed and the state of a bank changes from normally operating to distressed whenever its liabilities are larger than the banks' assets. The banks are connected through an interbank lending network and, whenever a bank is distressed, its creditor cannot expect the loan from the distressed bank to be repaid, potentially becoming distressed themselves. We solve the problem analytically for a homogeneous system and test the robustness and generality of the results with simulations of more complex systems. We investigate the parameter space and the corresponding distribution of operating banks mapping the conditions under which the whole system is stable or unstable. This allows us to determine how financial stability of a banking system is influenced by regulatory decisions, such as leverage; we discuss the effect of central bank actions, such as quantitative easing and we determine the cost of rescuing a distressed banking system using re-capitalisation. Finally, we estimate the stability of the UK and US banking systems in the years 2007 and 2012 showing that both banking systems were more unstable in 2007 and connectedness on the interbank market partly caused the banking crisis.
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Kartik Anand & Prasanna Gai & Sujit Kapadia & Simon Brennan & Matthew Willison, 2011.
"A Network Model of Financial System Resilience,"
SFB 649 Discussion Papers
SFB649DP2011-051, Sonderforschungsbereich 649, Humboldt University, Berlin, Germany.
- D. Garlaschelli & T. Di Matteo & T. Aste & G. Caldarelli & M. I. Loffredo, 2007. "Interplay between topology and dynamics in the World Trade Web," Papers physics/0701030, arXiv.org.
- Gai, Prasanna & Haldane, Andrew & Kapadia, Sujit, 2011. "Complexity, concentration and contagion," Journal of Monetary Economics, Elsevier, vol. 58(5), pages 453-470.
- Nier, Erlend & Yang, Jing & Yorulmazer, Tanju & Alentorn, Amadeo, 2007.
"Network models and financial stability,"
Journal of Economic Dynamics and Control,
Elsevier, vol. 31(6), pages 2033-2060, June.
- Franklin Allen & Elena Carletti & Douglas Gale, 2009.
"Interbank Market Liquidity and Central Bank Intervention,"
Economics Working Papers
ECO2009/09, European University Institute.
- Allen, Franklin & Carletti, Elena & Gale, Douglas, 2009. "Interbank market liquidity and central bank intervention," Journal of Monetary Economics, Elsevier, vol. 56(5), pages 639-652, July.
- Upper, Christian, 2011. "Simulation methods to assess the danger of contagion in interbank markets," Journal of Financial Stability, Elsevier, vol. 7(3), pages 111-125, August.
- Merton, Robert C, 1973. "An Intertemporal Capital Asset Pricing Model," Econometrica, Econometric Society, vol. 41(5), pages 867-87, September.
- Iori, G. & Kapar, B. & Olmo, J., 2012. "The Cross-Section of Interbank Rates: A Nonparametric Empirical Investigation," Working Papers 12/03, Department of Economics, City University London.
- Prasanna Gai & Nigel Jenkinson & Sujit Kapadia, 2007. "Systemic risk in modern financial systems: analytics and policy design," Journal of Risk Finance, Emerald Group Publishing, vol. 8(2), pages 156-165, March.
- S. Heise & R. Kühn, 2012. "Derivatives and credit contagion in interconnected networks," The European Physical Journal B - Condensed Matter and Complex Systems, Springer;EDP Sciences, vol. 85(4), pages 1-19, April.
- Langfield, Sam & Liu, Zijun & Ota, Tomohiro, 2014.
"Mapping the UK interbank system,"
Journal of Banking & Finance,
Elsevier, vol. 45(C), pages 288-303.
- Sebastian Heise & Reimer Kuehn, 2012. "Derivatives and Credit Contagion in Interconnected Networks," Papers 1202.3025, arXiv.org.
- D. Garlaschelli & T. Di Matteo & T. Aste & G. Caldarelli & M. I. Loffredo, 2007. "Interplay between topology and dynamics in the World Trade Web," The European Physical Journal B - Condensed Matter and Complex Systems, Springer;EDP Sciences, vol. 57(2), pages 159-164, 05.
- Iori, G. & Masi, G. D. & Precup, O. V. & Gabbi, G. & Caldarelli, G., 2005.
"A network analysis of the Italian oversight money market,"
05/05, Department of Economics, City University London.
- Iori, Giulia & De Masi, Giulia & Precup, Ovidiu Vasile & Gabbi, Giampaolo & Caldarelli, Guido, 2008. "A network analysis of the Italian overnight money market," Journal of Economic Dynamics and Control, Elsevier, vol. 32(1), pages 259-278, January.
- Furfine, Craig H, 2003. " Interbank Exposures: Quantifying the Risk of Contagion," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 35(1), pages 111-28, February.
- 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.
- Igor Tsatskis, 2012. "Systemic losses in banking networks: indirect interaction of nodes via asset prices," Papers 1203.6778, arXiv.org.
- Juan Solorzano-Margain & Serafin Martinez-Jaramillo & Fabrizio Lopez-Gallo, 2013. "Financial contagion: extending the exposures network of the Mexican financial system," Computational Management Science, Springer, vol. 10(2), pages 125-155, June.
When requesting a correction, please mention this item's handle: RePEc:arx:papers:1402.3688. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (arXiv administrators)
If references are entirely missing, you can add them using this form.