Market Frictions, Interbank Linkages and Excessive Interconnections
IMF Working Papers, August 26, 2016
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Bibliographic details
- Authors: Pragyan Deb
- Published: August 26, 2016
- Series: IMF Working Papers
- DOI: https://doi.org/10.5089/9781475530292.001
Summary and research question
- This paper studies banks' decision to form financial interconnections using a model of financial contagion that explicitly takes into account the crisis state of the world.
- The network formation decision is modeled as optimising behaviour of competitive banks that balance the benefits of forming interbank linkages against the cost of contagion.
- The framework is used to study various market frictions that can result in excessive interconnectedness observed during the crisis.
- The paper focuses on two channels that arise from regulatory intervention—deposit insurance and the too big to fail problem.
Methodology and model features
- Uses a model of financial contagion that explicitly takes into account the crisis state of the world.
- Models network formation as the optimizing decision of competitive banks.
- Balances benefits of interbank linkages against contagion costs.
- Analyzes effects of market frictions that stem from regulatory intervention.
Main findings and insights
- Market frictions linked to regulatory intervention can lead to excessive interconnectedness among banks.
- Two highlighted channels that contribute to excessive interconnections:
- Deposit insurance.
- The too big to fail problem.
Policy implications and considerations
- Regulatory design relating to deposit insurance and handling of systemically important institutions can influence banks' incentives to form interbank linkages.
- Addressing market frictions implied by deposit insurance and too-big-to-fail policies is important to mitigate excessive interconnectedness and reduce systemic contagion risk.
Subjects and keywords
- Subjects: Asset and liability management; Banking; Deposit insurance; Financial contagion; Financial crises; Financial institutions; Financial markets; Financial sector policy and analysis; Interbank markets; Liquidity; Systemically important financial institutions
- Keywords: bank depositor; bank portfolio; bank run; Contagion; deposit insurance; depositor payoff; depositor type; Financial contagion; financial crises; financial crisis; Global; impatient depositor; interbank deposit; Interbank markets; liquid asset; Liquidity; network formation; patient depositor; Systemically important financial institutions; too-big-to-fail; WP
IMF Working Paper by Pragyan Deb, "Market Frictions, Interbank Linkages and Excessive Interconnections", Working Paper No. 2016/180 (August 26, 2016).
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- Market Frictions, Interbank Linkages and Excessive Interconnections