Please use this identifier to cite or link to this item: https://hdl.handle.net/10419/278170 
Year of Publication: 
2022
Series/Report no.: 
ESRB Working Paper Series No. 136
Publisher: 
European Systemic Risk Board (ESRB), European System of Financial Supervision, Frankfurt a. M.
Abstract: 
This paper investigates how interbank credit exposures affect financial stability. Policy makers often see such exposures as undermining stability by exacerbating cascading losses through the financial system. I develop a model that features a trade-off between cascading losses and risk-sharing. In contrast to previous studies I find that reducing interbank connectivity may destabilize the financial system via the bank-run channel. This is because it decreases the risk-sharing benefits of interbank connectivity. A bank-run model features two islands that are connected via a long term debt claim. Varying the size of this claim (interbank connectivity), I study how the decision to 'run on the bank' is affected. I run a simulation of the model, calibrated to the U.S. banking system between 1997-2007. I find that large bankruptcy costs are required to trump the risk-sharing benefits of interbank credit exposures.
Subjects: 
financial stability
bank runs
credit risk
derivatives
JEL: 
G01
G21
G28
Persistent Identifier of the first edition: 
ISBN: 
978-92-9472-258-4
Document Type: 
Working Paper

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