Epidemics of Liquidity Shortages in Interbank Markets

Abstract

Financial contagion from liquidity shocks has being recently ascribed as a prominent driver of systemic risk in interbank lending markets. Building on standard compartment models used in epidemics, in this work we develop an EDB (Exposed-Distressed-Bankrupted) model for the dynamics of liquidity shocks reverberation between banks, and validate it on electronic market for interbank deposits data. We show that the interbank network was highly susceptible to liquidity contagion at the beginning of the 2007/2008 global financial crisis, and that the subsequent micro-prudential and liquidity hoarding policies adopted by banks increased the network resilience to systemic risk---yet with the undesired side effect of drying out liquidity from the market. We finally show that the individual riskiness of a bank is better captured by its network centrality than by its participation to the market, along with the currently debated concept of "too interconnected to fail".

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Cited by in corpus (6)

• The Physics of Financial Networks
• Systemic liquidity contagion in the European interbank market
• Combinatorial approach to spreading processes on networks
• Interbank network reconstruction enforcing density and reciprocity
• Dimensional Reduction of Solvency Contagion Dynamics on Financial Networks
• Integrating granular data into a multilayer network: an interbank model of the euro area for systemic risk assessment