Size and complexity in model financial systems
The global financial crisis has precipitated an increasing appreciation of the need for a systemic perspective towards financial stability. For example: What role do large banks play in systemic risk? How should capital adequacy standards recognize this role? How is stability shaped by concentration and diversification in the financial system? We explore these questions using a deliberately simplified, dynamical model of a banking system which combines three different channels for direct spillovers from one bank to another: liquidity hoarding, asset price contagion, and the propagation of defaults via counterparty credit risk. Importantly, we also introduce a mechanism for capturing how swings in ‘confidence’ in the system may contribute to instability. Our results highlight that the importance of relatively large, well-connected banks in system stability scales more than proportionately with their size: the impact of their collapse arises not only from their connectivity, but also from their effect on confidence in the system. Imposing tougher capital requirements on larger banks than smaller ones can thus enhance the resilience of the system. Moreover, these effects are more pronounced in more concentrated systems, and continue to apply even when allowing for potential diversification benefits which may be realised by larger banks. We discuss some tentative implications for policy, as well as conceptual analogies in ecosystem stability, and in the control of infectious diseases.
|Date of creation:||07 Oct 2012|
|Date of revision:|
|Contact details of provider:|| Postal: Bank of England, Threadneedle Street, London, EC2R 8AH|
Phone: +44 (0)171 601 4030
Fax: +44 (0)171 601 5196
Web page: http://www.bankofengland.co.uk/
More information through EDIRC
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.:
- Joseph G. Haubrich & Andrew W. Lo, 2013. "Quantifying Systemic Risk," NBER Books, National Bureau of Economic Research, Inc, number haub10-1.
- Acharya, Viral V & Skeie, David, 2011.
"A Model of Liquidity Hoarding and Term Premia in Inter-Bank Markets,"
CEPR Discussion Papers
8705, C.E.P.R. Discussion Papers.
- Acharya, Viral V. & Skeie, David, 2011. "A model of liquidity hoarding and term premia in inter-bank markets," Journal of Monetary Economics, Elsevier, vol. 58(5), pages 436-447.
- Viral V. Acharya & David R. Skeie, 2011. "A model of liquidity hoarding and term premia in inter-bank markets," Staff Reports 498, Federal Reserve Bank of New York.
- Kartik Anand & Alan Kirman & Matteo Marsili, 2010. "Epidemics of rules, information aggregation failure and market crashes," Working Papers halshs-00545144, HAL.
- Kapadia, Sujit & Drehmann, Mathias & Elliott, John & Sterne, Gabriel, 2012.
"Liquidity risk, cash-flow constraints and systemic feedbacks,"
Bank of England working papers
456, Bank of England.
- Sujit Kapadia & Matthias Drehmann & John Elliott & Gabriel Sterne, 2012. "Liquidity Risk, Cash Flow Constraints, and Systemic Feedbacks," NBER Chapters, in: Quantifying Systemic Risk, pages 29-61 National Bureau of Economic Research, Inc.
- 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.
- Gai, Prasanna & Kapadia, Sujit, 2010. "Contagion in financial networks," Bank of England working papers 383, Bank of England.
- Soramäki, Kimmo & Bech, Morten L. & Arnold, Jeffrey & Glass, Robert J. & Beyeler, Walter E., 2007.
"The topology of interbank payment flows,"
Physica A: Statistical Mechanics and its Applications,
Elsevier, vol. 379(1), pages 317-333.
- Stefano Battiston & Domenico Delli Gatti & Mauro Gallegati & Bruce C. Greenwald & Joseph E. Stiglitz, 2009.
"Liaisons Dangereuses: Increasing Connectivity, Risk Sharing, and Systemic Risk,"
NBER Working Papers
15611, National Bureau of Economic Research, Inc.
- Battiston, Stefano & Delli Gatti, Domenico & Gallegati, Mauro & Greenwald, Bruce & Stiglitz, Joseph E., 2012. "Liaisons dangereuses: Increasing connectivity, risk sharing, and systemic risk," Journal of Economic Dynamics and Control, Elsevier, vol. 36(8), pages 1121-1141.
- 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.
- Wolf Wagner, 2011. "Systemic Liquidation Risk and the Diversity–Diversification Trade‐Off," Journal of Finance, American Finance Association, vol. 66(4), pages 1141-1175, 08.
- Gai, Prasanna & Haldane, Andrew & Kapadia, Sujit, 2011. "Complexity, concentration and contagion," Journal of Monetary Economics, Elsevier, vol. 58(5), pages 453-470.
When requesting a correction, please mention this item's handle: RePEc:boe:boeewp:0465. 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: (Digital Media Team)
If references are entirely missing, you can add them using this form.