Interconnectedness in the Interbank Market

Abstract

We study the behavior of the interbank market before, during and after the 2008 financial crisis. Leveraging recent advances in network analysis, we study two network structures, a correlation network based on publicly traded bank returns, and a physical network based on interbank lending transactions. While the two networks behave similarly pre-crisis, during the crisis the correlation network shows an increase in interconnectedness while the physical network highlights a marked decrease in interconnectedness. Moreover, these networks respond differently to monetary and macroeconomic shocks. Physical networks forecast liquidity problems while correlation networks forecast financial crises.