Bank interconnectedness and financial stability: The role of bank capital

Yehning Chen

Journal of Financial Stability, 2022, vol. 61, issue C

Abstract: This paper builds a network model to study the relation between financial stability and interconnectedness among banks. In the model, banks adopt a Value-at-Risk rule to determine capital ratios. It is shown that interconnectedness may hurt financial stability by amplifying the banks’ mistakes of underestimating risk, and that interconnectedness increases systemic risk. The results in the paper suggest that financial integration may hurt financial stability, and that bank interconnectedness is more harmful when the economy turns abruptly from boom to recession. In addition, banks should be given incentives to reduce interconnectedness if systemic risk is a serious concern for regulators.

Keywords: Financial network; Contagion; Interconnectedness; Diversification; Bank capital (search for similar items in EconPapers)
JEL-codes: G01 G21 (search for similar items in EconPapers)
Date: 2022
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (9)

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Persistent link: https://EconPapers.repec.org/RePEc:eee:finsta:v:61:y:2022:i:c:s1572308922000432

DOI: 10.1016/j.jfs.2022.101019

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