Resilience of Interbank Market Networks to Shocks

Shouwei Li,Jianmin He

doi:10.1155/2011/594945

Abstract

This paper first constructs a tiered network model of the interbank market. Then, from the perspective of contagion risk, it studies numerically the resilience of four types of interbank market network models to shocks, namely, tiered networks, random networks, small-world networks, and scale-free networks. This paper studies the interbank market with homogeneous and heterogeneous banks and analyzes random shocks and selective shocks. The study reveals that tiered interbank market networks and random interbank market networks are basically more vulnerable against selective shocks, while small-world interbank market networks and scale-free interbank market networks are generally more vulnerable against random shocks. Besides, the results indicate that, in the four types of interbank market networks, scale-free networks have the highest stability against shocks, while small-world networks are the most vulnerable. When banks are homogeneous, faced with selective shocks, the stability of the tiered interbank market networks is slightly lower than that of random interbank market networks, whereas, in other cases, the stability of the tiered interbank market networks is basically between that of random interbank market networks and that of scale-free interbank market networks.

Highlights

Interbank markets play an essential role in modern financial systems
When the interaction cij is larger than or equal to c, we define an interbank credit lending relationship between node i and node j, where the value of the threshold is set by c, which is calculated as τ × cmax × cmin, with τ being a positive parameter, cmax and cmin the maximum and the minimum values of the bank credit degrees, respectively
In step ii, the determination of the interbank credit lending size is based on the interbank market network, that is, xij > 0, when there exists a link between bank i and bank j, or xij 0

Summary

Introduction

Interbank markets play an essential role in modern financial systems. In an interbank market, banks with liquidity shortages can borrow liquidity from banks with liquidity surpluses. Nier et al 29 model the tiered structure by classifying the banks in the network into large and small banks and find that tiered structures are not necessarily more prone to systemic risk and that whether they are or not depends on the degree of centrality, which is the number of connections to the central node Such that, as the degree of centrality increases, contagious defaults first increase but start to decrease, as the number of connections to the central node starts to lead to greater dissipation of the shock. We still cannot obtain a clear picture about whether there exists a certain network that can well withstand shocks, that is, the one that has a high stability against shocks Motivated by these considerations, we construct in this paper a tiered network model and numerically analyze contagion risk on different types of networks and study how resilient different network models are against shocks.

Tiered Interbank Market Network Model

Constructing Bank Balance Sheets

Shocks and Shock Transmission

Parameters of Models for Simulations

Simulation Results

Conclusion