We develop a DSGE model incorporating a banking sector comprising 4 banks connected in a stylised network representing their interbank exposures. The micro-founded framework allows inter alia for endogenous bank defaults and bank capital requirements. In addition, we introduce a central bank who intervenes directly in the interbank market through liquidity injections. Model dynamics are driven by standard productivity as well as banking sector shocks. In our simulations, we incorporate four different interbank network structures: Complete, cyclical and two variations of the core-periphery topology. Comparison of interbank market dynamics under the different topologies reveals a strong stabilising role played by the complete network while the remaining structures show a non-negligible shock propagation mechanism. Finally, we show that central bank interventions can counteract negative banking shocks with the effect depending again on the network structure.
Interbank network DSGE model banking liquidity injections