A new paper by Farooq Akram and Casper Christophersen entitled “Interbank overnight interest rates – gains from systemic importance” analyses the Norvegian overnight interbank interest rates paid by banks. They find that during the Financial crisis, the interest rates were substantially below indicative quotes of interest rates provided by major banks. The interest rate variation is explained by the relative size and connectedness of the banks, implying favorable terms for banks of systemic importance.
Moreover, interest rates are found to depend not only on overall liquidity in the interbank market, but possibly on its distribution among banks as well, suggesting exploitation of market power by banks with surplus liquidity. They also find evidence of stronger effects on interest rates of systemic importance, credit ratings and liquidity demand and supply since the start of the current financial crisis.
An open-source implementation of the algorithm for uncovering the interbank loans was developed as part of this project. The algorithm is available as part of the Financial Network Analyzer.
Update on financial network research
The summer was a busy time for research on financial networks, ranging from interlinkages between economies via interbank money markets to financial infrastructures. One sentence summaries of eight papers are below. Let me know if you have a relevant paper or work that I can add to the list.
“Analysing Interconnectivity among Economies”
Alfred Wong and Tom Fong study how interconnected relationships between economies can be disentangled into simple and quantifiable bilateral interdependence linkages, using 11 Asia-Pacific economies as an example. Hong Kong Monetary Authority Working Papers No. 1003. (download)
“Systemic risk, financial contagion and financial fragility”
Serafín Martínez-Jaramillo, Omar Pérez Péreza, Fernando Avila Embriza and Fabrizio López Gallo Deya model systemic risk with two main components: a random shock that weakens one or more financial institutions and a transmission mechanism which transmits and possibly exacerbates such negative effects to the rest of the banking network. Journal of Economic Dynamics and Control (in press, link to sciencedirect)
“Systemic risk in a network model of interbank markets with central bank activity”
Co-Pierre Georg and Jenny Poschmann investigate which influence central bank activity has on interbank markets. Jena Economic Research Papers No. 2010-033. (download)
“Peer monitoring or contagion? Interbank market exposure and bank risk”
F.R. Liedorp, L. Medema, M. Koetter, R.H. Koning, and I. van Lelyveld test if interconnectedness in the interbank market is a channel through which banks affect each others riskiness. The evidence is based on quarterly bilateral exposures of all banks active in the Dutch interbank market between 1998 and 2008. DNB working paper No. 248. (download).
“The sterling unsecured loan market during 2006-08: insights from network theory”
Anne Wetherilt, Peter Zimmerman and Kimmo Soramäki analyze empirically the unsecured overnight money market in the United Kingdom as a network of relationships and examine how the structure has changed over the recent period of crisis. Bank of England Working Paper No 398. (download)
“What do network theory and endogenous risk theory have to say about the effects of central counterparties on systemic stability?”
Jean-Pierre Zigrand’s paper considers what network theory can say about the effects of CCPs on systemic stability and how do different CCP structures (e.g. one vs multiple CCPs) alter systemic risk. Banque de France Financial Stability Review No 14. (download)
“Liquidity costs and tiering in large-value payment systems”
Mark Adams, Marco Galbiati and Simone Giansante develop and simulates a model of the emergence of networks in an interbank RTGS payment system. Bank of England Working Paper No. 399. (download)
“Liquidity-saving mechanisms and bank behaviour”
Marco Galbiati and Kimmo Soramäki develop a simple agent based model and investigate the effect of liquidity-saving mechanisms (LSMs) in interbank payment systems. The paper is published as Bank of England Working Paper No 400. (download)