Formation of Optimal Interbank Lending Networks under Liquidity Shocks

  title={Formation of Optimal Interbank Lending Networks under Liquidity Shocks},
  author={Daniel E. Rigobon and Ronnie Sircar},
  journal={SSRN Electronic Journal},
We formulate a model of the banking system in which banks control both their supply of liquidity, through cash holdings, and their exposures to risky interbank loans. The value of interbank loans jumps when banks suffer liquidity shortages, which can be caused by the arrival of large enough liquidity shocks. In two distinct settings, we compute the unique optimal allocations of capital. In the first, banks seek only to maximize their own utility – in a decentralized manner. Second, a central… 

Figures and Tables from this paper



Interbank Lending and Systemic Risk

Systemic risk refers to the propagation of a bank's economic distress to other economic agents linked to that bank through financial transactions. Banking authorities often prevent systemic risk

Systemic Risk in Endogenous Financial Networks

We provide a framework to study the formation of financial networks and investigate the interplay between the banks’ lending incentives and the emergence of systemic risk. We show that under natural

Intermediation and Voluntary Exposure to Counterparty Risk

I develop a model of the financial sector in which endogenous intermediation among debt financed banks generates excessive systemic risk. Financial institutions have incentives to capture

Liquidity Risk and Contagion

This paper explores liquidity risk in a system of interconnected financial institutions when these institutions are subject to regulatory solvency constraints and mark their assets to market. When

Stability Analysis of Financial Contagion Due to Overlapping Portfolios

A network approach to the amplification of financial contagion due to the combination of overlapping portfolios and leverage is developed, and it is shown how it can be understood in terms of a generalized branching process.

Endogenous Banks' Networks, Cascades and Systemic Risk

We develop a dynamic network model whose links are governed by banks' optimizing decisions and by an endogenous tâtonnement market adjustment. Banks in our model can default and engage in firesales:

Complexity, concentration and contagion

Managing Default Contagion in Inhomogeneous Financial Networks

The aim of this paper is to quantify and manage systemic risk caused by default contagion in the interbank market. We model the market as a random directed network, where the vertices represent

The Formation of Financial Networks

Modern banking systems are highly interconnected. Despite their various benefits, the linkages that exist between banks carry the risk of contagion. In this paper we investigate how banks decide on

A mathematical treatment of bank monitoring incentives

In this paper, we take up the analysis of a principal/agent model with moral hazard introduced by Pagès (J. Financ. Intermed. doi:10.1016/j.jfi.2012.06.001, 2012), with optimal contracting between