Interbank Connections Research Articles

Interbank Connections, Bank Risk and Returns

Abstract Using data on MENA country-banks, we study how interbank connections affect bank risk and returns. The findings indicate that interbank connections are determinantal to bank stability in the MENA region during periods of crisis, supportive of contagion effects. There is also a dampening impact on profitability. Over and above, the evidence for Islamic banks is supportive of contagion effects during the crisis, although their profitability is higher as well. Furthermore, macroprudential policies appear to exert a salutary impact on bank behavior, although this impact differs across the response variable: being effective for credit exposures with profits as the outcome and for funding exposure when non-performing loan ratio is the outcome variable.

Do Ex-Bankers Benefit Nonfinancial Firms? Evidence from Job Transitions

Abstract We document the beneficial impact of human capital transfer from banks to nonfinancial firms: firms hiring ex-bankers have higher asset and employment growth and easier access to bank loans. Using a unique employee-employer-matched data set from Russia and exogenous variation in ex-bankers’ supply due to bank-branch-network restructurings, we establish the causal interpretation of these patterns. We also show that ex-bankers’ human capital consists of bank-specific and banking industry expertise (with the latter being acquired through interbank connections). Firms recognize the value of ex-bankers, who receive significant salary bonuses when a new bank loan is issued to the firm (JEL G21, G32, J24). Received August 17, 2020; editorial decision January 5, 2022; by editor: Isil Erel. Authors have furnished an Internet Appendix, which is available on the Oxford University Press Web site next to the link to the final published paper online.

Students Perception About Digital Financial Services

The purpose of this research is to determine how the students from a Mexican university perceive the different digital financial services. For the study, the Durai and Stella (2019) test was used, which is made up of twelve indicators in a Likert format to assess the perception of digital services, based on their convenience, adaptability, affordability, security, user-friendliness, trailing fee, accurate timing, online monthly statement, quick financial decision making, interbank account accessibility and internet connectivity. The main findings point to the satisfaction that respondents feel towards digital financial services in the five dimensions that were studied: Internet Banking, Mobile Banking, Mobile Wallet, Credit Cards and Debit Cards. Student’s perception was extremely satisfactory towards Debit Card services, especially on the indicators of adaptability, affordability, security, user-friendliness, accurate timing, online monthly statement and portability. In addition, the Mobile Banking services had a positive impact on the Interbank account accessibility and Internet Connectivity. This could be explained by the way these current generations of young millennials easily handle technological use.

Interbank connections, contagion and bank distress in the Great Depression✰

Liquidity shocks transmitted through interbank connections contributed to bank distress during the Great Depression. New data on interbank connections reveal that banks were vulnerable to closures of their correspondents and their respondents. Further, banks were less responsive to network liquidity risk in their management of cash and capital buffers after the Federal Reserve was established, suggesting that banks expected the Fed to reduce that risk. The Fed's presence weakened incentives for the most systemically important banks to maintain capital and cash buffers against liquidity risk, and thereby likely contributed to the banking system's vulnerability to contagion during the Depression.

Will energy transitions impact financial systems?

A low-carbon transition requires changes in the energy structure that may affect the financial system. However, little theoretical and empirical evidence has been produced regarding the interaction between different subsystems. This article presents empirical evidence regarding the relationship between energy and financial systems using the wavelet analysis which considers possible cyclical properties that change over time. The wavelet coherence coefficients based on the data for the United States suggest that the electricity price is closely related to shares of different energy-powered electricity production, but has weak relationships with the interbank connectivity and bank failures. The phase differences show that increases in nuclear energy-powered electricity generation reduce the electricity price at less than one and a half years of scale, but rise it at approximately three years of scale. However, different energy shares have little effect on the interbank connectivity. An increase in renewable energy in producing electricity may reduce the number of failed banks, whereas an increase in nuclear energy has an opposite effect. Therefore, the energy transition affects the financial system and excessively fast investment in nuclear energy may threat the bank sector and thus endanger the financial system. The Nuclear Renaissance program should be treated with caution.

Intervention on default contagion under partial information in a financial network.

We study the optimal interventions of a regulator (a central bank or government) on the illiquidity default contagion process in a large, heterogeneous, unsecured interbank lending market. The regulator has only partial information on the interbank connections and aims to minimize the fraction of final defaults with minimal interventions. We derive the analytical results of the asymptotic optimal intervention policy and the asymptotic magnitude of default contagion in terms of the network characteristics. We extend the results of Amini, Cont and Minca’s work to incorporate interventions and adopt the dynamics of Amini, Minca and Sulem’s model to build heterogeneous networks with degree sequences and initial equity levels drawn from arbitrary distributions. Our results generate insights that the optimal intervention policy is “monotonic” in terms of the intervention cost, the closeness to invulnerability and connectivity. The regulator should prioritize interventions on banks that are systematically important or close to invulnerability. Moreover, the regulator should keep intervening on a bank once having intervened on it. Our simulation results show a good agreement with the theoretical results.

Interbank Connections, Contagion and Bank Distress in the Great Depression

Interbank Connections, Contagion and Bank Distress in the Great Depression

Systemic Banking Crises: The Relationship Between Concentration and Interbank Connections

In this paper I study the extent to which the nexus between concentration and interbank linkages affects financial stability, using data for a sample of 19,689 banks in 69 countries from 1995 to 2014. I find that high levels of interbank exposures decrease the probability of observing a systemic banking crisis, when the banking system is either highly concentrated or fragmented. The relationship between concentration and stability is found to be non-monotonic, as predicted by Martinez-Miera & Repullo (2010), although not U-shaped.

Interbank Connections and Financial Stability

Interbank Connections and Financial Stability

Measuring bank contagion in Europe using binary spatial regression models

The recent European sovereign debt crisis clearly illustrates the importance of measuring the contagion effects of bank failures. Indeed, to better understand and monitor contagion risk, the European Central Bank has assumed the supervision of the largest banks in each of the member states. We propose a measure of contagion risk based on the spatial autocorrelation parameter of a binary spatial autoregressive model. Using different specifications of the interbank connectivity matrix, we estimate the contagion parameter for banks within the Eurozone, between 1996 and 2012. We provide evidence of high levels of systemic risk due to contagion during the European sovereign debt crisis.

Financial stability at risk due to investing rapidly in renewable energy

We present novel insights about effective energy policies using an agent-based model. The model describes relevant feedback mechanisms between technological evolution, the interbank market and the electricity sector. Analysis with it shows that energy policies affect interbank connectivity and hence the likelihood of cascades of bank failures. This effect has not been studied before in the literature. In particular, we find that investments in renewable energy reduce interbank connectivity, increasing the probability of bank failures, while raising taxes on energy has an opposite effect. Increasing the share of renewable energy in electricity production initially increases the price of electricity, and thus improves profits and the ability to re-pay debts of incumbent power plants. However, when the share of renewable energy increases too quickly, financial stability may be at stake as the burden of financing investments in renewable energy offsets the improved profitability of existing power stations. All in all, this study provides a unique and novel perspective on the relationship between renewable energy investments and financial stability.

Margin Procyclicality and Systemic Risk

We develop a model in which margin procyclicality, asset market depth and banks' propensity for liquidity hoarding interact to generate a systemic liquidity crisis. In this model, banks trade derivatives to hedge market risk or to speculate on interest rate movements. To mitigate counterparty credit risk, daily mark-to-market is required which results in daily margin calls. We show that when banks holdings of high quality liquid assets are insufficient to cover a margin call, banks hoard liquidity in the interbank market. Other banks might do the same leading to a liquidity hoarding contagion that is exacerbated by high interbank connectivity. We also show that distressed banks that do not have access to the interbank market sell their less liquid assets leading to consecutive declines in the price of these assets. This fire sale contagion is more severe if collateral haircuts are excessively high. Finally, we find that the propagation of systemic risk is unaffected by whether derivatives are centrally or bilaterally cleared, assuming the same daily mark-to-market rules apply.

Banker preferences, interbank connections, and the enduring structure of the Federal Reserve System

Established by a three person committee in 1914, the structure of the Federal Reserve System has remained essentially unchanged ever since, despite criticism at the time and over ensuing decades. This paper examines the original selection of cities for Reserve Banks and branches, and placement of district boundaries. We show that each aspect of the Fed's structure reflected the preferences of national banks, including adjustments to district boundaries after 1914. Further, using newly-collected data on interbank connections, we find that banker preferences mirrored established correspondent relationships. The Federal Reserve was thus formed on top of the structure that it was largely meant to replace.

Using Weighted Shapley Values to Measure the Systemic Risk of Interconnected Banks

AbstractA macro‐prudential approach to financial regulation should reasonably evaluate the systemic risk of individual institutions. We introduce a measure of the systemic risk of interconnected banks using the weighted Shapley value, which characterizes banks' systemic risk by capturing two characteristics: (i) a bank's risk exposure of the primitive asset structure; and (ii) its position in the interbank network. An empirical implementation reveals that the primitive asset structure and interbank connections are main drivers of each bank's systemic risk. In addition, different types of interbank linkages (debt or share) make significant differences in affecting an individual bank's systemic risk.

Systemic Risk -- Identification, Assessment and Monitoring based on Eigenvector Centrality Analysis of Thai Interbank Connectivity Matrices

This paper presents a coherent framework for identifying Systemically Important Financial Institutions (SIFI) and assessing the overall banking system's vulnerability to systemic phenomena from the viewpoint of banking system as a complex network of interconnected nodes generating pair-wise financial activities. The proposed parameter-free methodology comprises two parts, Systemic Importance Analysis (SIA), which rates and ranks individual financial institutions relative to one another in terms of systemic influence each exerts over the banking system overall, and Systemic Vulnerability Analysis (SVA), which tracks the banking system over time in terms of how the very pattern of connectivities (inter-connectedness) somehow enable 'small players' to exert 'large leverage' on system (in)stability. SIA & SVA both utilizes Bonacich's Eigenvector Centrality measure, essentially the principal eigenvector associated with a matrix of pair-wise connection strengths. Empirical results presented herewith are based on actual records (2009-) of interbank transactions between financial instiutions operating in Thailand (actual bank names masked by aliases).

The Role of Finance in Promoting Sustainable Development

The actual financial crisis put the emphasis in the study of the financial market structure to avoid the international contagion risk or systemic risk. The development of new financial instruments are necessary and the financial innovation is important to promoting the economic growth. In order to design a sustainable finance system it is necessary the consideration of economic fundamentals together with the classical legal figures, because those concepts have the historical data that we could use and put together to promoting sustainable development. In a globalized economic system the design of new financial product must be build up with the development of strong fiscal policies. We can’t ignore that emerging markets in modern times are explained, in part, by the greater similarity between the economic structures in many countries. And now, the emerging economies are better diversified and they engaged in more similar economic activities than they did in the past. The source of systemic risk today is not necessarily the source of systemic risk in the future. The increase in interbank connectivity creates more opportunities for financial development, but as the same time creates more opportunities for systemic risk contagion and transmission in the future.

Insights into European interbank network contagion

Purpose – The purpose of this paper is to analyse the importance of interbank connections and shocks on banks’ capital ratios to financial stability by looking at a network comprising a large number of European and UK banks. Design/methodology/approach – The authors model interbank contagion using insights from the Susceptible Infected Recovered model. The authors construct scale-free networks with preferential attachment and growth, applying simulated interbank data to capture the size and scale of connections in the network. The authors proceed to shock these networks per country and perform Monte Carlo simulations to calculate mean total losses and duration of infection. Finally, the authors examine the effects of contagion in terms of Core Tier 1 Capital Ratios for the affected banking systems. Findings – The authors find that shocks in smaller banking systems may cause smaller overall losses but tend to persist longer, leading to important policy implications for crisis containment. Originality/value – The authors infer the interbank domestic and cross-border exposures of banks employing an iterative proportional fitting procedure, called the RAS algorithm. The authors use an extend sample of 169 European banks, that also captures effects on the UK as well as the Eurozone interbank markets. Finally, the authors provide evidence of the contagion effect on each bank by allowing heterogeneity. The authors compare the bank’s relative financial strength with the contagion effect which is modelled by the number and the volume of bilateral connections.

A Microfounded Design of Interconnectedness-Based Macroprudential Regulation

The failure of large, complex and interconnected banks has severe consequences to the real economy. To address the challenges posed by globally systemically important banks (G-SIBs), the Basel Committee on Banking Supervision recommended an “additional loss absorbency requirement” for these institutions. Motivated by this instrument of macroprudential regulation, which reflects concern over contagion, I develop a microfounded design of interconnectedness-based capital charges. These charges increase the costs of establishing interbank connections, which leads to a non-monotonic welfare effect. While reduced interconnectedness decreases welfare by restricting banks’ ability to insure against liquidity shocks, it also increases it by reducing contagion in default states. Thus, the regulator faces a trade-off between efficiency and financial stability. I show that the trade-off implied by incentive compatible interconnectedness-based charges is steeper the stronger G-SIBs implicit support is when banks’ tail risk exposure is private information. This finding underscores the importance of complementary measures, such as resolution regimes, which mitigate these frictions and consequently reinforce the efficiency and effectiveness of these capital requirements.

Banker Preferences, Interbank Connections, and the Enduring Structure of the Federal Reserve System

Banker Preferences, Interbank Connections, and the Enduring Structure of the Federal Reserve System

Mapping the UK Interbank System

We present new evidence on the structure of interbank connections in key markets: derivatives, marketable securities, repo, unsecured lending and secured lending. Taken together, these markets comprise two networks: a network of interbank exposures and a network of interbank funding. Network structure varies across and within these two networks, for reasons related to markets’ different economic functions. Credit risk and liquidity risk therefore propagate in the interbank system through different network structures, with implications for financial stability.