A new paper by Farooq Akram and Casper Christophersen entitled “Interbank overnight interest rates – gains from systemic importance” analyses the Norwegian 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.

Recently the idea has been floated that systemically important financial institutions should be charged insurance premia to cover for government support in times of stress. The recent IMF report (April 2010) for G20 ministers now suggests that:

A risk-adjusted rate could be designed to address the contribution to systemic risk. Ideally, the rate would vary according to the size of the systemic risk externality, e.g., based on a network model which would take into account all possible channels of contagion.

In order to operationalize the network approach, however, more both theoretical and empirical research is needed – as well as access to more frequent and granular data.

New YorkTimes (1 May 2010) published a great visualization (Bill Marsh / The New York Times) of the debt relationships between European countries based on public data by BIS. Its reproduced below.

The Visual Science series of New York Times has many other captivating visualizations of data as well.

The ECB conference “Recent advances in modelling systemic risk using network analysis” was featured today in Securities Operations Week – a weekly publication focused on US and global securities operations, technology and compliance:

“The financial crisis that began to emerge in 2007 and that gained steam in 2008 famously gave rise to the oft-cited slogan “too big to fail” It also saw the coinage of a lesser-known catchphrase kicked around commonly now in research circles: “too networked to fail”. A summation released last week by the European Central Bank offers what may be the best discussion to date on the subject. [read the full article (pdf)]

The year is coming to an end and it a good time to look back at how this blog evolved during the year. I started it in March 2008 mainly as my personal blog but as I noticed that most of the articles covered financial networks in one sense or another, and that there was no other blog on the emerging area of financial networks research – I redesigned it during this year to what you see now. I also set up a LinkedId group to bring people working in the area together and for disseminating information on new research or conferences in the area. Please join if you are at LinkedIn.

Of course it is also interesting to know if anyone is reading this blog? According to Google Analytics installed on the site there is quite a steady readership of 80-100 unique visitors each week. Between 15 November and 15 December there were a total of 605 visits and 1667 page views. I think this is pretty good and motivates me to do an even better job in 2010. The below map shows the geographic distribution of the visitors.

Merry Christmas/Holidays and a Happy New Year to all the readers!

A few conference announcements from INSNA mailing list:

• NetSciCom 2010, Second IEEE International Workshop on Network Science For Communication Networks, March 19, 2010 – San Diego, CA, USA
• 6th UK Social Networks Conference to take place at University of Manchester from 12^th to 16^th of April 2010.
• Workshop on Financial Networks and Risk Assessment, May 19.21, 2010 in Toronto by MITACS
• Third Annual Political Networks Conference, May 19-21, 2010 at Duke University.
• IEEE First International Workshop on Social Networks to take place in Cape Town, South Africa, May 27, 2010. Accepted papers will be published at the IEEE Xplore.
• International Sunbelt Social Networks Conference to take place at Riva del Garda, Trento, Italy, from June 29 to July 4, 2010
• ASONAM 2010 to take place in Odense, Denmark, August 9-11, 2010. The proceedings will be published by IEEE Computer Society Press (pending final approval).
• 7th Conference on Applications of Social Network Analysis (ASNA) will be held in September 15-17, 2010 at ETH Zurich.
• CompleNet 2010, 2nd International Workshop on Complex Networks, Oct 13-15, 2010, Rio de Janeiro, Brasil

A testimony by Andrew Lo for the U.S. House of Representatives Financial Services Committee for its hearing on systemic risk regulation, held October 29, 2009. It proposes two major measures that could alleviate the next big financial crisis.

First, new legislation that provides more transparency on a confidential basis to regulators on financial institutions activities. This would allow measuring systemic risk using a variety of methods such as developing “network maps”.

Second, establishing a Capital Markets Safety Board (CMSB) devoted to measuring, tracking, and investigating systemic risk events. The board would manage the related data and analyse every financial wreckage in a similar manner as National Transportation Safety Board (NTSB) examines e.g. ariplane crashes.

A proposal for a new EU institution, European Systemic Risk Board, was published on 23 September 2009. The proposed body will have the mandate to map financial risks and their concentration at the system level for the macro-prudential supervision of systemic stability. European Union central banks will have a prominent role in it and the Secretariat of the ESRB will be entrusted to the European Central Bank. A press release from the same date explains the functioning of the new body in more detail.

I was recently interviewed for the article by Christopher Wright, now published in the CFA magazine (July/August 2009, Vol. 20, No. 4) and entitled "Six degrees of rumination – Is network theory the best hope for regulating systemic risk?". The article discusses whether and how network theory can be used to develop a "financial network theory" where the linkages between banks matter as much as the banks themselves. It is available for purchase from CFA website (for $3) or you can just get in touch with me and ask for a copy (unfortunately I can’t post it here).

A recent speech by Andy Haldane (Executive Director of Financial Stability at the Bank of England) "Rethinking the financial network" tackles the same topic. It likewise understands the financial system as a complex adaptive network, and looks how other sciences besides economics have tackled similar problems: from the behavioral effects in the spread of epidemics (vs. panics in financial markets) to the robustness enhancing effects of biodiversity (vs e.g. the Glass-Steagall act that created different financial institutions with different risk profiles).

I got my hands on this excellent "opinion paper" entitled "The Financial Crisis and the Systemic Failure of Academic Economics" by eight well known economists (Dahlem report). The paper outlines what went wrong with economics and finance in retrospect to the current crisis, and track it back (kindly said) to the failure of economics to address the questions that are most relevant to the society and not to make the shortcomings of its models clear.

"Many of the financial economists who developed the theoretical models upon which the modern financial structure is built were well aware of the strong and highly unrealistic restrictions imposed on their models to assure stability. Yet, financial economists gave little warning to the public about the fragility of their models; even as they saw individuals and businesses build a financial system based on their work."

The authors criticize heavily current representative agent economic models and hope that more efforts are put e.g. in network theory and agent based modeling.

"For example, the recent surge of research in network theory has received relatively scarce attention in economics. Given the established curriculum of economic programs, an economist would find it much more tractable to study adultery as a dynamic optimization problem of a representative husband, and derive the optimal time path of marital infidelity (and publish his exercise) rather than investigating financial flows in the banking sector within a network theory framework. This is more than unfortunate in view of the network aspects of interbank linkages that have become apparent during the current crisis."

I have collected a repository of such empirical research here. As is visible in the list, this work has already started at some central banks – as suggested in the report:

"We believe that it will be necessary for supervisory authorities to develop a perspective on the network aspects of the financial system, collect appropriate data, define measures of connectivity and perform macro stress testing at the system level. In this way, new measures of financial fragility would be obtained."