Bank Liquidity, Interbank Markets, and Monetary Policy

A major lesson of the recent financial crisis is that the interbank lending market is crucial for banks facing large uncertainty regarding their liquidity needs. This paper studies the efficiency of the interbank lending market in allocating funds. We consider two different types of liquidity shocks leading to di¤erent implications for optimal policy by the central bank. We show that, when confronted with a distribu- tional liquidity-shock crisis that causes a large disparity in the liquidity held among banks, the central bank should lower the interbank rate. This view implies that the traditional tenet prescribing the separation between prudential regulation and mon- etary policy should be abandoned. In addition, we show that, during an aggregate liquidity crisis, central banks should manage the aggregate volume of liquidity. Two di¤erent instruments, interest rates and liquidity injection, are therefore required to cope with the two di¤erent types of liquidity shocks. Finally, we show that failure to cut interest rates during a crisis erodes financial stability by increasing the risk of bank runs.bank liquidity;interbank markets;central bank policy;financial fragility;bank runs

Clearing algorithms and network centrality

I show that the solution of a standard clearing model commonly used in contagion analyses for financial systems can be expressed as a specific form of a generalized Katz centrality measure under conditions that correspond to a system-wide shock. This result provides a formal explanation for earlier empirical results which showed that Katz-type centrality measures are closely related to contagiousness. It also allows assessing the assumptions that one is making when using such centrality measures as systemic risk indicators. I conclude that these assumptions should be considered too strong and that, from a theoretical perspective, clearing models should be given preference over centrality measures in systemic risk analyses

Densely Entangled Financial Systems

In [1] Zawadoski introduces a banking network model in which the asset and counter-party risks are treated separately and the banks hedge their assets risks by appropriate OTC contracts. In his model, each bank has only two counter-party neighbors, a bank fails due to the counter-party risk only if at least one of its two neighbors default, and such a counter-party risk is a low probability event. Informally, the author shows that the banks will hedge their asset risks by appropriate OTC contracts, and, though it may be socially optimal to insure against counter-party risk, in equilibrium banks will {\em not} choose to insure this low probability event. In this paper, we consider the above model for more general network topologies, namely when each node has exactly 2r counter-party neighbors for some integer r>0. We extend the analysis of [1] to show that as the number of counter-party neighbors increase the probability of counter-party risk also increases, and in particular the socially optimal solution becomes privately sustainable when each bank hedges its risk to at least n/2 banks, where n is the number of banks in the network, i.e., when 2r is at least n/2, banks not only hedge their asset risk but also hedge its counter-party risk.Comment: to appear in Network Models in Economics and Finance, V. Kalyagin, P. M. Pardalos and T. M. Rassias (editors), Springer Optimization and Its Applications series, Springer, 201

How liquid are banks : some evidence from the United Kingdom

This paper uses quantitative balance sheet liquidity analysis, based upon modified versions of the BCBS 1 and Moody’s 2 models, to provide indicators which would alarm the UK banks’ short and long-term liquidity positions respectively. These information will also underpin other research related liquidity risk to banks’ lending and performance. Our framework accurately reflect UK banks’ liquidity positions under both normal and stress scenarios based on the consistent accounting information under IFRS. It has significant contribution on Basel III liquidity ratios calculation. The study also presents fundamental financial information to facilitate analysis of banks’ business models and funding strategies. Using data for the period 2005-2010, we provide evidence that there have been variable liquidity strains across the UK banks in our sample. The estimated results show that Barclays Bank was the only bank to maintain a healthy short-term liquidity position throughout the sample period; while HSBC remained liquid in the short term, in both normal and stress conditions, except in 2008 and 2010. RBS, meanwhile, maintained healthy long-term liquidity positions from 2008 after receiving government injections of capital. And Santander UK was also able to post healthy long-term liquidity positions, except in 2009. However, the other four banks, the Bank of Scotland, Lloyds TSB, Natwest, and Standard Chartered, proved illiquid, on both a short-term and long-term basis, throughout the six-year period, with Natwest being by far the worst performer

Do bad borrowers hurt good borrowers? A model of biased banking competition

This paper explores a two-bank model in which, first, one bank correctly estimates the probability of low-quality loan repayment while the other overestimates it, and second, both banks have identical convex costs when granting loans. In this context of optimistically biased banking competition, we show how the unbiased bank follows the biased competitor as long as the bias of the latter is not too large. This would favour bad borrowers, who get better credit conditions at the expense of good borrowers. As a consequence, the presence of a biased bank increases welfare as long as the expected default rate is sufficiently high. Contrariwise, in subprime markets, biased banking competition would be socially harmful.info:eu-repo/semantics/publishedVersio

On the Computational Complexity of Measuring Global Stability of Banking Networks

Threats on the stability of a financial system may severely affect the functioning of the entire economy, and thus considerable emphasis is placed on the analyzing the cause and effect of such threats. The financial crisis in the current and past decade has shown that one important cause of instability in global markets is the so-called financial contagion, namely the spreading of instabilities or failures of individual components of the network to other, perhaps healthier, components. This leads to a natural question of whether the regulatory authorities could have predicted and perhaps mitigated the current economic crisis by effective computations of some stability measure of the banking networks. Motivated by such observations, we consider the problem of defining and evaluating stabilities of both homogeneous and heterogeneous banking networks against propagation of synchronous idiosyncratic shocks given to a subset of banks. We formalize the homogeneous banking network model of Nier et al. and its corresponding heterogeneous version, formalize the synchronous shock propagation procedures, define two appropriate stability measures and investigate the computational complexities of evaluating these measures for various network topologies and parameters of interest. Our results and proofs also shed some light on the properties of topologies and parameters of the network that may lead to higher or lower stabilities.Comment: to appear in Algorithmic