Monetary policy implementation in an interbank network: Effects on systemic risk

Marcel Bluhm, Ester Faia and Jan Krahnen ()

No 46, SAFE Working Paper Series from Leibniz Institute for Financial Research SAFE

Abstract: This paper makes a conceptual contribution to the e ffect of monetary policy on financial stability. We develop a microfounded network model with endogenous network formation to analyze the impact of central banks' monetary policy interventions on systemic risk. Banks choose their portfolio, including their borrowing and lending decisions on the interbank market, to maximize profit subject to regulatory constraints in an asset-liability framework. Systemic risk arises in the form of multiple bank defaults driven by common shock exposure on asset markets, direct contagion via the interbank market, and firesale spirals. The central bank injects or withdraws liquidity on the interbank markets to achieve its desired interest rate target. A tension arises between the bene ficial effects of stabilized interest rates and increased loan volume and the detrimental effects of higher risk taking incentives.We fi nd that central bank supply of liquidity quite generally increases systemic risk.

Keywords: network formation; contagion; central banks' interventions (search for similar items in EconPapers)
JEL-codes: C63 D85 G01 G28 (search for similar items in EconPapers)
Date: 2014
New Economics Papers: this item is included in nep-ban, nep-cba, nep-ger, nep-mon, nep-net and nep-rmg
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (19)

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Persistent link: https://EconPapers.repec.org/RePEc:zbw:safewp:46

DOI: 10.2139/ssrn.2417219

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