Title: Interbank Networks Formed through Money Creation, Too Connected to Fail and Systemic Risk
Institution: University of Essex
Abstract: This paper presents a new approach to endogenize interbank credit networks, based on banks' specialty that their liabilities are accepted as a means of payment. This approach takes into account how borrowing on banks' asset side affects depositing on their liability side in general equilibrium. This approach is applied to endogenize a star structured interbank network with the aim of studying the issues of too connected to fail (TCTF) and systemic risk. In the model the banking system melts down on equilibrium path. Moreover, (1) the resources are inefficiently concentrated at the center of the network and the higher the interbank rate, the worse the efficiency; (2) the network of interbank credit alone has no issue of TCTF, which, however, arises if interbank insurance is also introduced; (3) this insurance becomes cheaper if the interbank rate is higher and it makes loss if the rate goes above a threshold; (4) early news matters more for systemic stability than late one; and (5) there is a zone of news based on which the event of system meltdown is likely to happen, but has not happened yet. This type of news provides an early warning of the event.
Time: 16:00-17:30, Mar 28th