Working Paper: CEPR ID: DP8793
Authors: Gabrielle Demange
Abstract: An intricate web of claims and obligations ties together the balance sheets of a wide variety of financial institutions. Under the occurrence of default, these interbank claims generate externalities across institutions and possibly disseminate defaults and bankruptcy. Building on a simple model for the joint determination of the repayments of interbank claims, this paper introduces a measure of the threat that a bank poses to the system. Such a measure, called threat index, may be helpful to determine how to inject cash into banks so as to increase debt reimbursement, or to assess the contributions of individual institutions to the risk in the system. Although the threat index and the default level of a bank both reflect some form of weakness and are affected by the whole liability network, the two indicators differ. As a result, injecting cash into the banks with the largest default level may not be optimal.
Keywords: bankruptcy; contagion; contagion in financial networks; a threat index; financial linkages; systemic risk
JEL Codes: G01; G21; G28
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| Decrease in a bank's net worth (G21) | Decrease in overall debt payments (H63) |
| A bank's default (G21) | Impact on the repayment capabilities of its creditors (F65) |
| A bank's default (G21) | Cascading effect of defaults among creditors (G33) |
| Injecting cash into banks with the largest threat index (F65) | Improve debt reimbursement (G51) |