A structural model of interbank network formation and contagion

Patrick Coen and Jamie Coen ()
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Patrick Coen: London School of Economics
Jamie Coen: London School of Economics and Bank of England

No 833, Bank of England working papers from Bank of England

Abstract: The interbank network, in which banks compete with each other to supply and demand differentiated financial products, fulfils an important function but may also result in risk propagation. We examine this trade-off by setting out a model in which banks form interbank network links endogenously, taking into account the effect of links on default risk. We estimate this model based on novel, granular data on aggregate exposures between banks. We find that the decentralised interbank market is not efficient: a social planner would be able to increase surplus on the interbank market by 13% without increasing mean bank default risk or decrease mean bank default risk by 4% without decreasing interbank surplus. We then propose two novel regulatory interventions (caps on aggregate exposures and pairwise capital requirements) that result in efficiency gains.

Keywords: Contagion; systemic risk; interbank network; network formation (search for similar items in EconPapers)
JEL-codes: G18 G28 L13 L51 (search for similar items in EconPapers)
Pages: 58 pages
Date: 2019-10-11
New Economics Papers: this item is included in nep-ban, nep-cba and nep-fmk
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Persistent link: https://EconPapers.repec.org/RePEc:boe:boeewp:0833

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