Sandcastles and Financial Systems: A Sandpile Metaphor

Francesco Luna and Luisa Zanforlin

No 2025/041, IMF Working Papers from International Monetary Fund

Abstract: Social welfare costs from bank resolution, including contagion and moral hazard, are often thought to be minimized when supervisors can direct the merger of a failing bank with a sound, healthy one. However, social losses may become even larger if the absorbing institutions fail themselves. We ask whether social welfare losses are indeed lower when supervisors intervene rather than not. We use the sand pile/Abelian model as a metaphor to model financial losses which, as sand grains that fall onto a pile, eventually lead to a slide/failure. When capital in the system is insufficient to absorb the failing institution there will be welfare losses. Results suggest that, over the longer-term, social costs are lower when supervisors manage mergers. Additionally, financial networks that have a structure that minimizes social losses also minimize crises frequency. However, the bank employed resolution strategy will determine which financial network structures are associated with the minimum average loss per bankruptcy event.

Keywords: Applied Abelian model; Banking; Financial Networks; Financial Economics; Banking Crisis; Bankrupcy; Bank Resolution; Selforganized Criticality; Bank Regulation and Supervision; welfare loss; resolution strategy; loss distribution; bank resolution regime supervisor; banks fail; shareholder bank; Distressed institutions; Commercial banks; Crisis resolution; Global (search for similar items in EconPapers)
Pages: 46
Date: 2025-02-14
New Economics Papers: this item is included in nep-fdg
References: Add references at CitEc
Citations:

Downloads: (external link)
http://www.imf.org/external/pubs/cat/longres.aspx?sk=562023 (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:imf:imfwpa:2025/041

Ordering information: This working paper can be ordered from
http://www.imf.org/external/pubs/pubs/ord_info.htm

Access Statistics for this paper

More papers in IMF Working Papers from International Monetary Fund International Monetary Fund, Washington, DC USA. Contact information at EDIRC.
Bibliographic data for series maintained by Akshay Modi ().