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A structural model of interbank network formation and contagion

Author

Listed:
  • Coen, Patrick

    (London School of Economics)

  • Coen, Jamie

    () (London School of Economics and Bank of England)

Abstract

The interbank network, in which banks compete with each other to supply and demand differentiated financial products, fulfils an important function but may also result in risk propagation. We examine this trade-off by setting out a model in which banks form interbank network links endogenously, taking into account the effect of links on default risk. We estimate this model based on novel, granular data on aggregate exposures between banks. We find that the decentralised interbank market is not efficient: a social planner would be able to increase surplus on the interbank market by 13% without increasing mean bank default risk or decrease mean bank default risk by 4% without decreasing interbank surplus. We then propose two novel regulatory interventions (caps on aggregate exposures and pairwise capital requirements) that result in efficiency gains.

Suggested Citation

  • Coen, Patrick & Coen, Jamie, 2019. "A structural model of interbank network formation and contagion," Bank of England working papers 833, Bank of England.
  • Handle: RePEc:boe:boeewp:0833
    as

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    References listed on IDEAS

    as
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    More about this item

    Keywords

    Contagion; systemic risk; interbank network; network formation;

    JEL classification:

    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation
    • L13 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - Oligopoly and Other Imperfect Markets
    • L51 - Industrial Organization - - Regulation and Industrial Policy - - - Economics of Regulation

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