The effect of the interbank network structure on contagion and common shocks

This paper proposes a dynamic multi-agent model of a banking system with central bank. Banks optimize a portfolio of risky investments and riskless excess reserves according to their risk, return, and liquidity preferences. They are linked via interbank loans and face stochastic deposit supply. Comparing different interbank network structures, it is shown that money-centre networks are more stable than random networks. Evidence is provided that the central bank stabilizes interbank markets in the short run only. Systemic risk via contagion is compared with common shocks and it is shown that both forms of systemic risk require different optimal policy responses.     

Interbank connections,contagion and bank distress in the Great Depression✰

Liquidity shocks transmitted through interbank connections contributed to bank distress during the Great Depression. New data on interbank connections reveal that banks were vulnerable to closures of their correspondents and their respondents. Further, banks were less responsive to network liquidity risk in their management of cash and capital buffers after the Federal Reserve was established, suggesting that banks expected the Fed to reduce that risk. The Fed's presence weakened incentives for the most systemically important banks to maintain capital and cash buffers against liquidity risk, and thereby likely contributed to the banking system's vulnerability to contagion during the Depression.     

资产透明度、监管套利与银行系统性风险

资产不透明的金融机构过度依赖批发性融资进行监管套利不利于系统性风险的防控。在此背景下,本文首先在经典银行道德风险模型的基础上引入关联性,从资产透明度和监管套利的视角分析银行系统性风险累积的内在机理。而后利用2007-2018年中国上市银行微观数据,构建资产透明度指标和系统性风险指标(SRISK、MES),对理论推论进行实证检验。主要结论有:(1)资产不透明、监管套利会提高银行的系统性风险。(2)监管套利弱化了资产透明度和资本监管机制对银行系统性风险承担的约束作用,资产透明度与资本监管机制在约束系统性风险承担中的协调作用不明显。(3)以大银行为主的债权银行受监管套利的影响相较于受资产透明度的影响更明显。在此基础上,我们对完善金融风险防范体系以及监管机制提出了若干建议。     

Optimal liquidity management and bail-out policy in the banking industry

We characterize the profit-maximizing reserves of a commercial bank, and the generated probability of a liquidity crisis, as a function of the penalty imposed by the Central Bank, the probability of depositors' liquidity needs, and the return on outside investment opportunities. We demonstrate that banks do not fully internalize the social cost associated with the bail-out policy if the liquidity needs of individuals are correlated, and that competitive interbank markets will induce banks to raise their reserves under reasonable conditions. The marginal benefits from an interbank market decrease as the correlation between the liquidity shocks of banks increases.     

Lending relationships in the interbank market

We use a unique dataset to show that relationships are an important determinant of banks' ability to access interbank market liquidity. More precisely, we find that: (i) banks with a larger reserve imbalance are more likely to borrow funds from banks with whom they have a relationship, and to pay a lower interest rate than otherwise; (ii) smaller banks and banks with more non-performing loans tend to have limited access to international markets, and rely more on relationships; (iii) relationships are established between banks with less correlated liquidity shocks. These results suggest that relationships allow banks to insure liquidity risk in the presence of market frictions such as transaction and information costs. Our analysis explicitly controls for the endogeneity of bank relationships.     

Can banks default overnight? Modelling endogenous contagion on the O/N interbank market

We propose a new model of the liquidity-driven banking system focusing on overnight interbank loans. This significant branch of the interbank market is commonly neglected in the banking system modelling and systemic risk analysis. We construct a model where banks are allowed to use both the interbank and the securities markets to manage their liquidity demand and supply as driven by prudential requirements in a volatile environment. The network of interbank loans is dynamic and simulated every day. We show how the intrasystem cash fluctuations alone, without any external shocks, may lead to systemic defaults, and what may be a symptom of the self-organized criticality of the system. We also analyze the impact of different prudential regulations and market conditions on the interbank market resilience. We confirm that the central bank’s asset purchase programmes, limiting the declines in government bond prices, can successfully stabilize banks’ liquidity demands. The model can be used to analyze the interbank market impact of macroprudential tools.     

Bank market power,asset liquidity and funding liquidity: International evidence

Our investigation of the association between bank market power and liquidity in 101 countries reveals that a bank's initial gains of market power lead to increases in bank liquidity, but does so at a diminishing rate. Beyond an empirically determined threshold, further increases in market power are inversely associated with bank liquidity. From a cross-sectional viewpoint, banks that lack market power hold more liquid assets and are net lenders in the interbank market. In contrast, dominant banks hold less liquid assets and are net interbank borrowers. For a given level of market power, ceteris paribus, developed nation banks hold less asset liquidity and obtain more interbank funding liquidity than their developing country peers. These results remain equally relevant during the 2007–2009 global financial crisis (GFC).     

Bond market development and bank stability: Evidence from emerging markets

We investigate how bond market development shapes banks’ risk taking in terms of portfolio structure, liquidity risk, and overall bank risk. Exploiting a bank-level database of 26 emerging markets, we find that larger bond markets are associated with stronger bank liquidity positions, lower portfolio risk of banks, and higher overall stability of banks. The effect of bond market development on bank risk taking remains robust across different levels of bank size and capital sufficiency. Overall, we find new evidence of a complementary relationship between bond market development and bank soundness.     

Liquidity Risk,Bank Networks,and the Value of Joining the Federal Reserve System

Reducing systemic liquidity risk related to seasonal loan demand was one reason for founding the Federal Reserve System. Nevertheless, less than 8% of state‐chartered banks joined the Fed in its first decade. Banks facing high liquidity risk from seasonal loan demand were more likely to join the Fed in its first decade. We also find evidence consistent with the notion that banks could obtain some indirect access to the discount window through interbank transfers. Some banks apparently joined the Fed to pass through discount window liquidity to other banks via the interbank network.  Joining the Fed increased member banks’ lending.     

Sukuk market development and Islamic banks’ capital ratios

This paper investigates the impact of Sukuk market development on Islamic banks’ capital ratios using a sample comprising 230 Islamic banks spanning the period 2005–2014. We characterize Islamic bank capital along multiple dimensions, namely: capital adequacy ratio, Tier 1 capital ratio, and capital-to-total assets ratio. We employ both the Prais-Winston technique and the system GMM estimator to tackle potential omitted variable bias, endogeneity, and simultaneity issues. The evidence shows that Sukuk market development has had a negative effect on capital ratios of Islamic banks. We argue that the development of Sukuk markets may have stimulated the competition between Islamic Banks, inducing them to hold lower capital ratios. Our results also show that trade openness and bank liquidity are positively and significantly related to capital ratios, while bank size and loan loss reserve ratio are negatively and significantly related to capital ratios, as expected.     

Liquidity risk management and credit supply in the financial crisis

Liquidity dried up during the financial crisis of 2007-2009. Banks that relied more heavily on core deposit and equity capital financing, which are stable sources of financing, continued to lend relative to other banks. Banks that held more illiquid assets on their balance sheets, in contrast, increased asset liquidity and reduced lending. Off-balance sheet liquidity risk materialized on the balance sheet and constrained new credit origination as increased takedown demand displaced lending capacity. We conclude that efforts to manage the liquidity crisis by banks led to a decline in credit supply.     

Network reactions to banking regulations

Optimal regulatory restrictions on banks have to solve a delicate balance. Tighter regulations reduce the likelihood of banks’ distress. Looser regulations foster the allocation of funds toward productive investments. With multiple banks, optimal regulation becomes even more challenging. Banks form partnerships in the interbank lending market in order to face liquidity needs and to meet investment possibilities. We show that the interbank network can suddenly collapse when regulations are pushed beyond a critical level, with a discontinuous increase in systemic risk as the cross-insurance of banks collapses.     

Money and liquidity in financial markets

We argue that there is a connection between the interbank market for liquidity and the broader financial markets, which has its basis in demand for liquidity by banks. Tightness in the market for liquidity leads banks to engage in what we term “liquidity pull-back,” which involves selling financial assets either by banks directly or by levered investors. Empirical tests on the stock market are supportive. Tighter interbank markets are associated with relatively more volume in more liquid stocks; selling pressure, especially in more liquid stocks; and transitory negative returns. We control for market-wide uncertainty and in the process also contribute to the literature on portfolio rebalancing. Our general point is that money matters in financial markets.     

Systemic liquidity shortages and interbank network structures

This paper aims to shed light on the systemic nature of liquidity risk and to propose a method for calculating systemic liquidity shortages. Our method incorporates not only direct liquidity shortages but also indirect liquidity shortages due to the knock-on effects through interbank linkages. We perform a simulation with a simple banking system model and find that a deficit bank can mitigate a liquidity shortage by holding more claims on a surplus bank. Meanwhile, a greater imbalance in liquidity positions across banks tends to aggravate the liquidity shortage of a deficit bank. According to comparative analysis between different types of network structures, a core-periphery network with a deficit money center bank gives rise to the highest level of systemic liquidity shortage, and a banking system becomes more vulnerable to liquidity shocks as its interbank network becomes more ill-matched.     

A Theory of Bank Capital

Banks can create liquidity precisely because deposits are fragile and prone to runs. Increased uncertainty makes deposits excessively fragile, creating a role for outside bank capital. Greater bank capital reduces the probability of financial distress but also reduces liquidity creation. The quantity of capital influences the amount that banks can induce borrowers to pay. Optimal bank capital structure trades off effects on liquidity creation, costs of bank distress, and the ability to force borrower repayment. The model explains the decline in bank capital over the last two centuries. It identifies overlooked consequences of having regulatory capital requirements and deposit insurance.     

The dark side of liquidity regulation: Bank opacity and funding liquidity risk

We evaluate how the liquidity coverage rule affects US banks’ opacity and funding liquidity risk. Banks subject to the rule become significantly more opaque and funding liquidity risk increases by $245 million per quarter. Higher funding liquidity risk is more pronounced among banks that are subject to the rule’s more stringent liquidity buffers, and systemically riskier banks. Rising opacity reflects an increase in banks’ holdings of complex assets whose value is difficult to communicate to investors. The evidence highlights the unintended consequences of liquidity regulation and is consistent with theoretical models’ predictions of a trade-off between liquidity buffers and bank opacity that exacerbates funding liquidity risk.     

Liquidity Crunch in the Interbank Market: Is it Credit or Liquidity Risk, or Both?

The interplay between liquidity and credit risks in the interbank market is analyzed. Banks are hit by idiosyncratic random liquidity shocks. The market may also be hit by bad news at a future date, implying the insolvency of some participants and creating a lemons problem; this may end up with a gridlock of the interbank market at that date. Anticipating such possible contingency, banks currently long of liquidity ask a liquidity premium for lending beyond a short maturity, as a compensation for the risk of being short of liquidity later and being forced to liquidate some illiquid assets. When such premium gets too high, banks currently short of liquidity prefer to borrow short term. The model is able to explain some stylized facts of the 2007–2009 liquidity crunch affecting the money market at the international level: (i) high spreads between interest rates at different maturities; (ii) “flight to overnight” in traded volumes; (iii) ineffectiveness of open market operations, leading the central banks to introduce some relevant innovations into their operational framework.     

Bank liquidity regulation and the lender of last resort

Banks can make suboptimal liquidity choices and gamble for lender of last resort (LOLR) support. Endogenous bailout rents are driven by the need to preserve bankers' incentives under uncertain net worth. In equilibrium, banks can herd in risk management, choosing suboptimal liquidity when they expect others to do so. Optimal liquidity can be restored by quantitative requirements, but such regulation is costly. An LOLR policy incorporating bank capital information can reduce distorting rents and allow for a more efficient solution, but may only be possible in transparent economies.     

Balancing liquidity and returns through interbank markets: Endogenous interest rates and network structures

In this article, we develop a model of interbank lending based on liquidity and return on equity considerations of homogeneous banks. We derive the reservation prices of interbank lending and its properties before exploring how, because of an idiosyncratic liquidity shock, banks engage in bilateral lending to form an interbank network. We establish that the resulting networks exhibit realistic properties, including a core-periphery structure. Banks in the core and the periphery of this network differ not only in the amounts of interbank lending and borrowing but also in the interest rates applied to their transactions.     

Borrowers under water! Rare disasters,regional banks,and recovery lending

We show that local banks provide corporate recovery lending to firms affected by adverse regional macro shocks. Banks that reside in counties unaffected by the natural disaster that we specify as macro shock increase lending to firms inside affected counties by 3%. Firms domiciled in flooded counties, in turn, increase corporate borrowing by 16% if they are connected to banks in unaffected counties. We find no indication that recovery lending entails excessive risk-taking or rent-seeking. However, within the group of shock-exposed banks, those without access to geographically more diversified interbank markets exhibit more credit risk and less equity capital.