PART IV - NETWORKS

Summary

Networks: Introduction

Events leading to the recent financial crisis have underlined the importance of financial contagion: scenarios in which the failure of a financial institution lead to subsequent losses or default of other financial institutions, leading eventually to a large-scale failure of the financial system. Standard economic models of banking which have traditionally focused on a single representative bank, interacting with borrowers or a central bank, do not have much to say about such contagion phenomena, whose modeling requires a representation of the interlinkages between financial institutions and market participants. Such interlinkages have naturally motivated the use of network models in the analysis of systemic risk.

Early theoretical work on the stability of interbank networks – for instance the pioneering studies by Allen and Gale (2000) and Rochet and Tirole (1996) – have underlined the importance of interbank liabilities for understanding systemic risk in the framework of stylized network structures. Empirical studies by central banks on the structure of interbank payment systems and balance sheet interlinkages have subsequently revealed that interbank networks have a complex, heterogeneous structure and that care must be taken when applying insights derived from simple, homogeneous network models. An important challenge is to understand the mechanisms behind the emergence of these networks, the link between their structure and their stability properties, and the implications of network structure for the monitoring and regulation of systemic risk.