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(In)Efficient Interbank Networks

Author

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  • FABIO CASTIGLIONESI
  • NOEMI NAVARRO
Abstract
We study the efficiency properties of the formation of an interbank network. Banks face a trade‐off by establishing connections in the interbank market. On the one hand, banks improve the diversification of their liquidity risk and therefore can obtain a higher expected payoff. On the other hand, banks not sufficiently capitalized have risk‐shifting incentives that expose them to the risk of bankruptcy. Connecting to such risky banks negatively affects expected payoff. We show that both the optimal and the decentralized networks are characterized by a core‐periphery structure. The core is made of the safe banks, whereas the periphery is populated by the risky banks. Nevertheless, the two network structures coincide only if counterparty risk is sufficiently low. Otherwise, the decentralized network is underconnected as compared to the optimal one. Finally, we analyze mechanisms that can avoid the formation of inefficient interbank networks.

Suggested Citation

  • Fabio Castiglionesi & Noemi Navarro, 2020. "(In)Efficient Interbank Networks," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 52(2-3), pages 365-407, March.
    • Handle: RePEc:wly:jmoncb:v:52:y:2020:i:2-3:p:365-407
    DOI: 10.1111/jmcb.12664
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    Cited by:

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    2. Brassil, Anthony & Nodari, Gabriela, 2021. "A Density-Based estimator of core/periphery network structures," Journal of Banking & Finance, Elsevier, vol. 125(C).
    3. Fittje, Jens & Wagner, Helmut, 2020. "Networking topography and default contagion in China’s financial system," CEAMeS Discussion Paper Series 17/2020, University of Hagen, Center for East Asia Macro-economic Studies (CEAMeS).
    4. in 't Veld, Daan & van der Leij, Marco & Hommes, Cars, 2020. "The formation of a core-periphery structure in heterogeneous financial networks," Journal of Economic Dynamics and Control, Elsevier, vol. 119(C).
    5. Di Xiao & Andreas Krause, 2023. "Balancing liquidity and returns through interbank markets: Endogenous interest rates and network structures," Journal of Financial Research, Southern Finance Association;Southwestern Finance Association, vol. 46(1), pages 131-149, February.
    6. Brunetti, Celso & Harris, Jeffrey H. & Mankad, Shawn, 2023. "Networks, interconnectedness, and interbank information asymmetry," Journal of Financial Stability, Elsevier, vol. 67(C).
    7. Celso Brunetti & Jeffrey H. Harris & Shawn Mankad, 2021. "Liquidity Networks, Interconnectedness, and Interbank Information Asymmetry," Finance and Economics Discussion Series 2021-017, Board of Governors of the Federal Reserve System (U.S.).
    8. Kosenko, Konstantin & Michelson, Noam, 2022. "It takes more than two to tango: Multiple bank lending, asset commonality and risk," Journal of Financial Stability, Elsevier, vol. 61(C).
    9. Morteza Alaeddini & Philippe Madiès & Paul J. Reaidy & Julie Dugdale, 2023. "Interbank money market concerns and actors’ strategies—A systematic review of 21st century literature," Journal of Economic Surveys, Wiley Blackwell, vol. 37(2), pages 573-654, April.
    10. Biswas, Swarnava S. & Gómez, Fabiana, 2018. "Contagion through common borrowers," Journal of Financial Stability, Elsevier, vol. 39(C), pages 125-132.
    11. Choi, Seungho & Gam, Yong Kyu & Park, Junho & Shin, Hojong, 2020. "Bank partnership and liquidity crisis," Journal of Banking & Finance, Elsevier, vol. 120(C).
    12. Mario Eboli & Bulent Ozel & Andrea Teglio & Andrea Toto, 2023. "Connectivity, centralisation and ‘robustness-yet-fragility’ of interbank networks," Annals of Finance, Springer, vol. 19(2), pages 169-200, June.

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    More about this item

    JEL classification:

    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

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