Bank networks and systemic risk

Abstract

The economic analysis of bank networks and systemic risk is an important issue for academics, policy makers and stakeholders. This paper proposes an analytical approach based on Freixas et al (2000) by using game theory and network graphs, where banks are represented by nodes and the credit lines by links. Additionally, this paper proposes a modeling where the principal result is the debt distribution of one insolvent bank in the bank network with the objective to maintain the bank system integrity in the event of a bank’s insolvency. Two risk scenarios in the bank networks are analyzed: one with a diversified regime and another with a less resilient regime. In the first case, when all banks are solvent, there is not systemic risk contagion. In the second case, when one bank is insolvent and has liquidity problems, a mechanism is implemented to resume control over systemic risk contagion and operate with normality provided that the rest of the bank network could cover insolvent bank credit lines. The second result of this paper is to propose a control mechanism and a systemic risk parameter that helps in preventing systemic risk in a bank network by adjusting money velocity. This adjustment helps reduce social costs losses, which are associated with financial and real economic crises.