The effect of the interbank network structure on contagion and common shocks

This paper proposes a dynamic multi-agent model of a banking system with central bank. Banks optimize a portfolio of risky investments and riskless excess reserves according to their risk, return, and liquidity preferences. They are linked via interbank loans and face stochastic deposit supply. Comparing different interbank network structures, it is shown that money-centre networks are more stable than random networks. Evidence is provided that the central bank stabilizes interbank markets in the short run only. Systemic risk via contagion is compared with common shocks and it is shown that both forms of systemic risk require different optimal policy responses. (C) 2013 Elsevier B.V. All rights reserved.