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Contagion and risk-sharing on the inter-bank market

  • Dan Ladley


Increasing inter-bank lending has an ambiguous impact on financial stability. Two opposing effects have been identified: promoting stability through risk sharing and providing a channel through which contagion may spread. In this paper we identify the conditions under which each relationship holds. In response to large economy-wide shocks, greater numbers of inter-bank lending relationships are shown to worsen systemic events, however, for smaller shocks the opposite effect is observed. As such there is no optimal inter-bank market structure which maximizes stability under all conditions. In contrast, deposit insurance costs are always reduced under greater numbers of inter-bank lending relationships.

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Paper provided by Department of Economics, University of Leicester in its series Discussion Papers in Economics with number 11/10.

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Date of creation: Nov 2010
Date of revision: Jan 2013
Handle: RePEc:lec:leecon:11/10
Contact details of provider: Postal: Department of Economics University of Leicester, University Road. Leicester. LE1 7RH. UK
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