Resilience of the Interbank Network to Shocks and Optimal Bail-Out Strategy: Advantages of "Tiered" Banking Systems
Systemic risk and the scale of systemic breakdown in the banking system are the key concern for central banks charged with safeguarding overall financial stability. This paper focuses on the risk and potential impact of system-wide defaults in the frequently observed ”tiered” banking system, where relatively few first-tier head institutions are connected with second-tier ”peripheral” banks and are also connected with each other, while the peripheral banks are almost exclusively connected with the head banks. The banking network is constructed from a number of banks which are linked by interbank exposures with a certain predefined probability. In this framework, the tiered structure is represented either by a network with negative correlation in connectivity of neighboring banks, or alternatively, by a network with a scale-free distribution of connectivity across banks. The main finding of the paper highlights the advantages of tiering within the banking system in terms of both the resilience of the banking network to systemic shocks and the extent of necessary government intervention should a crisis evolve. Specifically, the tiered network structure, showing negative correlations in bank connectivity, is found to be less prone to systemic breakdown than other structures, showing either positive or zero correlations. Moreover, in the scale-free tiered system, the resilience of the system to shocks increases as the level of tiering grows. Also, the targeted bail-out policy of the government aimed at rescuing the most connected failing banks in the first place, is expected to be more effective and induce lower costs in a tiered system with high level of tiering.
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.:
- 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.
- Yaron Leitner, 2005. "Financial Networks: Contagion, Commitment, and Private Sector Bailouts," Journal of Finance, American Finance Association, vol. 60(6), pages 2925-2953, December.
- Helmut Elsinger & Alfred Lehar & Martin Summer, 2006.
"Risk Assessment for Banking Systems,"
INFORMS, vol. 52(9), pages 1301-1314, September.
- Xavier Freixas & Bruno Parigi & Jean Charles Rochet, 1998.
"Systemic risk, interbank relations and liquidity provision by the Central Bank,"
Economics Working Papers
440, Department of Economics and Business, Universitat Pompeu Fabra, revised Sep 1999.
- Xavier Freixas & Bruno M. Parigi & Jean-Charles Rochet, 2000. "Systemic risk, interbank relations, and liquidity provision by the central bank," Proceedings, Federal Reserve Bank of Cleveland, pages 611-640.
- Freixas, Xavier & Parigi, Bruno M & Rochet, Jean-Charles, 2000. "Systemic Risk, Interbank Relations, and Liquidity Provision by the Central Bank," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 32(3), pages 611-38, August.
- Freixas, Xavier & Parigi, Bruno & Rochet, Jean-Charles, 1999. "Systemic Risk, Interbank Relations and Liquidity Provision by the Central Bank," CEPR Discussion Papers 2325, C.E.P.R. Discussion Papers.
- X. Freixas & B. Parigi & J-C. Rochet, 2000. "Systemic Risk, Interbank Relations and Liquidity Provision by theCentral Bank," DNB Staff Reports (discontinued) 47, Netherlands Central Bank.
- repec:dgr:kubtil:2006016 is not listed on IDEAS
- Sandro Brusco & Fabio Castiglionesi, 2005.
"Liquidity Coinsurance, Moral Hazard and Financial Contagion,"
Department of Economics Working Papers
05-12, Stony Brook University, Department of Economics.
- Sandro Brusco & Fabio Castiglionesi, 2007. "Liquidity Coinsurance, Moral Hazard, and Financial Contagion," Journal of Finance, American Finance Association, vol. 62(5), pages 2275-2302, October.
- Andrea Galeotti & Sanjeev Goyal, 2007.
"A Theory of Strategic Diffusion,"
Economics Discussion Papers
635, University of Essex, Department of Economics.
- Upper, Christian & Worms, Andreas, 2002.
"Estimating Bilateral Exposures in the German Interbank Market: Is there a Danger of Contagion?,"
Discussion Paper Series 1: Economic Studies
2002,09, Deutsche Bundesbank, Research Centre.
- Christian Upper & Andreas Worms, 2001. "Estimating bilateral exposures in the German interbank market: is there a danger of contagion?," BIS Papers chapters, in: Bank for International Settlements (ed.), Marrying the macro- and micro-prudential dimensions of financial stability, volume 1, pages 211-229 Bank for International Settlements.
- Upper, Christian & Worms, Andreas, 2004. "Estimating bilateral exposures in the German interbank market: Is there a danger of contagion?," European Economic Review, Elsevier, vol. 48(4), pages 827-849, August.
- Paolo Emilio Mistrulli, 2007.
"Assessing financial contagion in the interbank market: Maximum entropy versus observed interbank lending patterns,"
Temi di discussione (Economic working papers)
641, Bank of Italy, Economic Research and International Relations Area.
- Mistrulli, Paolo Emilio, 2011. "Assessing financial contagion in the interbank market: Maximum entropy versus observed interbank lending patterns," Journal of Banking & Finance, Elsevier, vol. 35(5), pages 1114-1127, May.
- Acharya, Viral V & Yorulmazer, Tanju, 2005. "Cash-in-the-Market Pricing and Optimal Bank Bailout Policy," CEPR Discussion Papers 5154, C.E.P.R. Discussion Papers.
- 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.
- 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 & Martin Summer & Stefan Thurner, 2004. "Contagion Flow Through Banking Networks," Papers cond-mat/0403167, arXiv.org.
- 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.
- repec:dgr:kubcen:2007100 is not listed on IDEAS
When requesting a correction, please mention this item's handle: RePEc:vie:viennp:1203. 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: (Paper Administrator)
If references are entirely missing, you can add them using this form.