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Systemic risk, interbank relations and liquidity provision by the Central Bank

Xavier Freixas, +2 more
- 01 Aug 2000 - 
- Vol. 32, Iss: 3, pp 611-638
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TLDR
In this paper, the authors model systemic risk in an interbank market and investigate the ability of the banking system to withstand the insolvency of one bank and whether the closure of a bank generates a chain reaction on the rest of the system.
Abstract
We model systemic risk in an interbank market. Banks face liquidity needs as consumers are uncertain about where they need to consume. Interbank credit lines allow to cope with these liquidity shocks while reducing the cost of maintaining reserves. However, the interbank market exposes the system to a coordination failure (gridlock equilibrium) even if all banks are solvent. When one bank is insolvent, the stability of the banking system is affected in various ways depending on the patterns of payments across locations. We investigate the ability of the banking system to withstand the insolvency of one bank and whether the closure of one bank generates a chain reaction on the rest of the system. We analyze the coordinating role of the Central Bank in preventing payments systemic repercussions and we examine the justification of the Too-big-to-fail-policy.

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Contagion in Financial Networks

TL;DR: The authors developed an analytical model of contagion in financial networks with arbitrary structure and explored how the probability and potential impact of contagions is influenced by aggregate and idiosyncratic shocks, changes in network structure, and asset market liquidity.
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Systemic risk and stability in financial networks

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Network topology of the interbank market

TL;DR: In this article, the authors provide an empirical analysis of the network structure of the Austrian interbank market based on Austrian Central Bank (OeNB) data and find that the degree distributions of the interbank network follow power laws.
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Competition and Financial Stability

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Complexity, concentration and contagion

TL;DR: In this paper, the authors develop a network model of interbank lending in which unsecured claims, repo activity and shocks to the haircuts applied to collateral assume centre stage, and show how systemic liquidity crises of the kind associated with the interbank market collapse of 2007-2008 can arise within such a framework, with funding contagion spreading widely through the web of interlinkages.
References
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Journal ArticleDOI

Bank Runs, Deposit Insurance, and Liquidity

TL;DR: The authors showed that bank deposit contracts can provide allocations superior to those of exchange markets, offering an explanation of how banks subject to runs can attract deposits, and showed that there are circumstances when government provision of deposit insurance can produce superior contracts.
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Monopolistic competition with outside goods

TL;DR: In this article, a model of spatial competition in which a second commodity is explicitly treated is presented, and it is shown that a zero-profit equilibrium with symmetrically located firms may exhibit rather strange properties.
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The Role of Demandable Debt in Structuring Optimal Banking Arrangements

TL;DR: Demandable-debt finance by banks warrants explanation because it entails costs of bank suspension, liquidation, and idle reserve holdings as mentioned in this paper, and an explanation is developed in which demandable debt provides incentive-compatible intermediation where the banker has comparative advantage in allocating investment funds but may act against the interests of uninformed depositors.
Journal ArticleDOI

Optimal Financial Crises

TL;DR: Bank runs can be first-best efficient: they allow efficient risk sharing between early and late withdrawing depositors and they allow banks to hold efficient portfolios as mentioned in this paper. But, if costly runs or markets for risky assets are introduced, central bank intervention of the right kind can lead to a Pareto improvement in welfare.
Journal ArticleDOI

Banking panics and business cycles

TL;DR: The authors examined the seven panics during the U.S. National Banking Era (1863-1914) and examined depositor behavior under subsequent monetary regimes, concluding that panics are caused by the same relations governing consumer behavior during nonpanic times.
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Trending Questions (1)
How does the interbank market affect the performance of banks?

Interbank market allows banks to manage liquidity shocks efficiently but can lead to systemic risk due to coordination failures, impacting banking system stability and requiring Central Bank intervention.