How the interbank market becomes systemically dangerous: an agent-based network model of financial distress propagation
The speed of a financial crisis outbreak sets the maximum delay before intervention by central authorities is no longer effective.
Network Theory of Finance 3, 1 (2015)
M. Serri, G. Caldarelli, G. Cimini
















Assessing the stability of economic systems is a fundamental research focus in economics, that has become increasingly interdisciplinary in the currently troubled economic situation. In particular, much attention has been devoted to the interbank lending market as an important diffusion channel for financial distress during the recent crisis. In this work we study the stability of the interbank market to exogenous shocks using an agent-based network framework. Our model encompasses several ingredients that have been recognized in the literature as pro-cyclical triggers of financial distress in the banking system: credit and liquidity shocks through bilateral exposures, liquidity hoarding due to counterparty creditworthiness deterioration, target leveraging policies and fire-sales spillovers. But we exclude the possibility of central authorities intervention. We implement this framework on a dataset of 183 European banks that were publicly traded between 2004 and 2013. We document the extreme fragility of the interbank lending market up to 2008, when a systemic crisis leads to total depletion of market equity with an increasing speed of market collapse. After the crisis instead the system is more resilient to systemic events in terms of residual market equity. However, the speed at which the crisis breaks out reaches a new maximum in 2011, and never goes back to values observed before 2007. Our analysis points to the key role of the crisis outbreak speed, which sets the maximum delay for central authorities intervention to be effective.
More in Systemic risk
Modelling financial systemic risk
Complex networks model the links between financial institutions and how these channels can transition from diversifying to propagating risk.
Default cascades in networks
The optimal architecture of a financial system is only dependent on its topology when the market is illiquid, and no topology is always superior.
Non-linear distress propagation
Non-linear models of distress propagation in financial networks characterise key regimes where shocks are either amplified or suppressed.
Cascades in flow networks
Coupled distribution grids are more vulnerable to a cascading systemic failure but they have larger safe regions within their networks.
Immunisation of systemic risk
Targeted immunisation policies limit distress propagation and prevent system-wide crises in financial networks according to sandpile models.
The interbank network
The large-scale structure of the interbank network changes drastically in times of crisis due to the effect of measures from central banks.
Interbank controllability
Complex networks detect the driver institutions of an interbank market and ascertain that intervention policies should be time-scale dependent.
The price of complexity
Increasing the complexity of the network of contracts between financial institutions decreases the accuracy of estimating systemic risk.
DebtRank and shock propagation
A dynamical microscopic theory of instability for financial networks reformulates the DebtRank algorithm in terms of basic accounting principles.
Bootstrapping topology and risk
Information about 10% of the links in a complex network is sufficient to reconstruct its main features and resilience with the fitness model.