IDEAS home Printed from https://ideas.repec.org/a/eee/finsta/v61y2022ics1572308922000432.html
   My bibliography  Save this article

Bank interconnectedness and financial stability: The role of bank capital

Author

Listed:
  • Chen, Yehning

Abstract

This paper builds a network model to study the relation between financial stability and interconnectedness among banks. In the model, banks adopt a Value-at-Risk rule to determine capital ratios. It is shown that interconnectedness may hurt financial stability by amplifying the banks’ mistakes of underestimating risk, and that interconnectedness increases systemic risk. The results in the paper suggest that financial integration may hurt financial stability, and that bank interconnectedness is more harmful when the economy turns abruptly from boom to recession. In addition, banks should be given incentives to reduce interconnectedness if systemic risk is a serious concern for regulators.

Suggested Citation

  • Chen, Yehning, 2022. "Bank interconnectedness and financial stability: The role of bank capital," Journal of Financial Stability, Elsevier, vol. 61(C).
  • Handle: RePEc:eee:finsta:v:61:y:2022:i:c:s1572308922000432
    DOI: 10.1016/j.jfs.2022.101019
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S1572308922000432
    Download Restriction: Full text for ScienceDirect subscribers only

    File URL: https://libkey.io/10.1016/j.jfs.2022.101019?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to search for a different version of it.

    References listed on IDEAS

    as
    1. Nicola Gennaioli & Andrei Shleifer & Robert W. Vishny, 2013. "A Model of Shadow Banking," Journal of Finance, American Finance Association, vol. 68(4), pages 1331-1363, August.
    2. Wagner, Wolf, 2010. "Diversification at financial institutions and systemic crises," Journal of Financial Intermediation, Elsevier, vol. 19(3), pages 373-386, July.
    3. Matthew Baron & Wei Xiong, 2017. "Credit Expansion and Neglected Crash Risk," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 132(2), pages 713-764.
    4. Antonio Cabrales & Piero Gottardi & Fernando Vega-Redondo, 2017. "Risk Sharing and Contagion in Networks," The Review of Financial Studies, Society for Financial Studies, vol. 30(9), pages 3086-3127.
    5. Viral V. Acharya & Lasse H. Pedersen & Thomas Philippon & Matthew Richardson, 2017. "Measuring Systemic Risk," The Review of Financial Studies, Society for Financial Studies, vol. 30(1), pages 2-47.
    6. Isil Erel & Taylor Nadauld & René M. Stulz, 2014. "Why Did Holdings of Highly Rated Securitization Tranches Differ So Much across Banks?," The Review of Financial Studies, Society for Financial Studies, vol. 27(2), pages 404-453.
    7. Daron Acemoglu & Asuman Ozdaglar & Alireza Tahbaz-Salehi, 2015. "Systemic Risk and Stability in Financial Networks," American Economic Review, American Economic Association, vol. 105(2), pages 564-608, February.
    8. Allen, Franklin & Babus, Ana & Carletti, Elena, 2012. "Asset commonality, debt maturity and systemic risk," Journal of Financial Economics, Elsevier, vol. 104(3), pages 519-534.
    9. Christian Brownlees & Robert F. Engle, 2017. "SRISK: A Conditional Capital Shortfall Measure of Systemic Risk," The Review of Financial Studies, Society for Financial Studies, vol. 30(1), pages 48-79.
    10. Tobias Adrian & Hyun Song Shin, 2014. "Procyclical Leverage and Value-at-Risk," The Review of Financial Studies, Society for Financial Studies, vol. 27(2), pages 373-403.
    11. Joseph E. Stiglitz, 2010. "Risk and Global Economic Architecture: Why Full Financial Integration May Be Undesirable," American Economic Review, American Economic Association, vol. 100(2), pages 388-392, May.
    12. Beltratti, Andrea & Stulz, René M., 2012. "The credit crisis around the globe: Why did some banks perform better?," Journal of Financial Economics, Elsevier, vol. 105(1), pages 1-17.
    13. Matthew Baron & Itay Goldstein, 2020. "Countercyclical Bank Equity Issuance," The Review of Financial Studies, Society for Financial Studies, vol. 33(9), pages 4186-4230.
    14. Ibragimov, Rustam & Jaffee, Dwight & Walden, Johan, 2011. "Diversification disasters," Journal of Financial Economics, Elsevier, vol. 99(2), pages 333-348, February.
    15. Nier, Erlend & Yang, Jing & Yorulmazer, Tanju & Alentorn, Amadeo, 2007. "Network models and financial stability," Journal of Economic Dynamics and Control, Elsevier, vol. 31(6), pages 2033-2060, June.
    16. Eboli, Mario, 2019. "A flow network analysis of direct balance-sheet contagion in financial networks," Journal of Economic Dynamics and Control, Elsevier, vol. 103(C), pages 205-233.
    17. Mr. Luc Eyraud & Ms. Diva Singh & Mr. Bennett W Sutton, 2017. "Benefits of Global and Regional Financial Integration in Latin America," IMF Working Papers 2017/001, International Monetary Fund.
    18. Matthew Elliott & Benjamin Golub & Matthew O. Jackson, 2014. "Financial Networks and Contagion," American Economic Review, American Economic Association, vol. 104(10), pages 3115-3153, October.
    19. Yaron Leitner, 2005. "Financial Networks: Contagion, Commitment, and Private Sector Bailouts," Journal of Finance, American Finance Association, vol. 60(6), pages 2925-2953, December.
    20. Ricardo J. Caballero & Alp Simsek, 2013. "Fire Sales in a Model of Complexity," Journal of Finance, American Finance Association, vol. 68(6), pages 2549-2587, December.
    21. Ing-Haw Cheng & Harrison Hong & José A. Scheinkman, 2015. "Yesterday's Heroes: Compensation and Risk at Financial Firms," Journal of Finance, American Finance Association, vol. 70(2), pages 839-879, April.
    22. Gennaioli, Nicola & Shleifer, Andrei & Vishny, Robert, 2012. "Neglected risks, financial innovation, and financial fragility," Journal of Financial Economics, Elsevier, vol. 104(3), pages 452-468.
    23. Ralph De Haas & Neeltje Van Horen, 2012. "International Shock Transmission after the Lehman Brothers Collapse: Evidence from Syndicated Lending," American Economic Review, American Economic Association, vol. 102(3), pages 231-237, May.
    24. Rüdiger Fahlenbrach & Robert Prilmeier & René M. Stulz, 2012. "This Time Is the Same: Using Bank Performance in 1998 to Explain Bank Performance during the Recent Financial Crisis," Journal of Finance, American Finance Association, vol. 67(6), pages 2139-2185, December.
    25. Shin, Hyun Song, 2008. "Risk and liquidity in a system context," Journal of Financial Intermediation, Elsevier, vol. 17(3), pages 315-329, July.
    26. Glasserman, Paul & Young, H. Peyton, 2015. "How likely is contagion in financial networks?," Journal of Banking & Finance, Elsevier, vol. 50(C), pages 383-399.
    27. Ralph De Haas & Neeltje Van Horen, 2012. "International shock transmission after the Lehman Brothers collapse – evidence from syndicated lending," Working Papers 142, European Bank for Reconstruction and Development, Office of the Chief Economist.
    28. Chitru S. Fernando & Anthony D. May & William L. Megginson, 2012. "The Value of Investment Banking Relationships: Evidence from the Collapse of Lehman Brothers," Journal of Finance, American Finance Association, vol. 67(1), pages 235-270, February.
    29. Joshua Coval & Jakub Jurek & Erik Stafford, 2009. "The Economics of Structured Finance," Journal of Economic Perspectives, American Economic Association, vol. 23(1), pages 3-25, Winter.
    30. Paul Glasserman & Peyton Young, 2015. "Contagion in Financial Networks," Economics Series Working Papers 764, University of Oxford, Department of Economics.
    31. Gai, Prasanna & Haldane, Andrew & Kapadia, Sujit, 2011. "Complexity, concentration and contagion," Journal of Monetary Economics, Elsevier, vol. 58(5), pages 453-470.
    32. Andrew Ellul & Vijay Yerramilli, 2013. "Stronger Risk Controls, Lower Risk: Evidence from U.S. Bank Holding Companies," Journal of Finance, American Finance Association, vol. 68(5), pages 1757-1803, October.
    33. Viral Acharya & Robert Engle & Matthew Richardson, 2012. "Capital Shortfall: A New Approach to Ranking and Regulating Systemic Risks," American Economic Review, American Economic Association, vol. 102(3), pages 59-64, May.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Gianluca Pallante & Mattia Guerini & Mauro Napoletano & Andrea Roventini, 2024. "Robust-less-fragile: Tackling Systemic Risk and Financial Contagion in a Macro Agent-Based Model," SciencePo Working papers Main hal-04576530, HAL.
    2. Svitlana Khalatur & Manuela Tvaronavičienė & Manuela Tvaronavičienė & Olena Dovgal & Olena Dovgal & Oksana Levkovich & Oksana Vodolazska, 2022. "Impact of selected factors on digitalization of financial sector," Entrepreneurship and Sustainability Issues, VsI Entrepreneurship and Sustainability Center, vol. 10(1), pages 358-377, September.
    3. Andrieş, Alin Marius & Chiper, Alexandra Maria & Ongena, Steven & Sprincean, Nicu, 2024. "External wealth of nations and systemic risk," Journal of Financial Stability, Elsevier, vol. 70(C).
    4. Elena G. Shershneva, 2024. "CAMELS parameters’ impact on the risk of losing financial stability: The case of Russian banks," Journal of New Economy, Ural State University of Economics, vol. 25(2), pages 130-152, July.
    5. Elena G. Shershneva, Min Zhou Hao, 2024. "Russian Banks Financial Stability Loss Diagnostic: Multidimensional Logit-Model Approach," Journal of Applied Economic Research, Graduate School of Economics and Management, Ural Federal University, vol. 23(2), pages 476-498.
    6. Michelangeli, Valentina & Piersanti, Fabio Massimo, 2023. "Interdependence between assets and liabilities in the banking system: Changes in the last two decades," Finance Research Letters, Elsevier, vol. 58(PA).

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Antonio Cabrales & Piero Gottardi & Fernando Vega-Redondo, 2017. "Risk Sharing and Contagion in Networks," The Review of Financial Studies, Society for Financial Studies, vol. 30(9), pages 3086-3127.
    2. Paltalidis, Nikos & Gounopoulos, Dimitrios & Kizys, Renatas & Koutelidakis, Yiannis, 2015. "Transmission channels of systemic risk and contagion in the European financial network," Journal of Banking & Finance, Elsevier, vol. 61(S1), pages 36-52.
    3. Shi, Qing & Sun, Xiaoqi & Jiang, Yile, 2022. "Concentrated commonalities and systemic risk in China's banking system: A contagion network approach," International Review of Financial Analysis, Elsevier, vol. 83(C).
    4. Carlos Ramírez, 2019. "Regulating Financial Networks Under Uncertainty," Finance and Economics Discussion Series 2019-056, Board of Governors of the Federal Reserve System (U.S.).
    5. Sullivan HUE & Yannick LUCOTTE & Sessi TOKPAVI, 2018. "Measuring Network Systemic Risk Contributions: A Leave-one-out Approach," LEO Working Papers / DR LEO 2608, Orleans Economics Laboratory / Laboratoire d'Economie d'Orleans (LEO), University of Orleans.
    6. Hué, Sullivan & Lucotte, Yannick & Tokpavi, Sessi, 2019. "Measuring network systemic risk contributions: A leave-one-out approach," Journal of Economic Dynamics and Control, Elsevier, vol. 100(C), pages 86-114.
    7. Jin-Wook Chang, 2019. "Collateralized Debt Networks with Lender Default," Finance and Economics Discussion Series 2019-083, Board of Governors of the Federal Reserve System (U.S.).
    8. Andrew Ellul & Dasol Kim, 2021. "Counterparty Choice, Bank Interconnectedness, and Systemic Risk," Working Papers 21-03, Office of Financial Research, US Department of the Treasury.
    9. Haelim Anderson & Mark Paddrik & Jessie Jiaxu Wang, 2019. "Bank Networks and Systemic Risk: Evidence from the National Banking Acts," American Economic Review, American Economic Association, vol. 109(9), pages 3125-3161, September.
    10. Ramírez, Carlos, 2020. "Regulating financial networks under uncertainty," ESRB Working Paper Series 107, European Systemic Risk Board.
    11. Paul Glasserman & H. Peyton Young, 2015. "Contagion in Financial Markets," Working Papers 15-21, Office of Financial Research, US Department of the Treasury.
    12. Li, Fei & Kang, Hao & Xu, Jingfeng, 2022. "Financial stability and network complexity: A random matrix approach," International Review of Economics & Finance, Elsevier, vol. 80(C), pages 177-185.
    13. Elliott, Matthew & Georg, Co-Pierre & Hazell, Jonathon, 2021. "Systemic risk shifting in financial networks," Journal of Economic Theory, Elsevier, vol. 191(C).
    14. Spiros Bougheas & Adam Hal Spencer, 2022. "Fire sales and ex ante valuation of systemic risk: A financial equilibrium networks approach," Discussion Papers 2022/04, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
    15. Rüdiger Frey & Juraj Hledik, 2018. "Diversification and Systemic Risk: A Financial Network Perspective," Risks, MDPI, vol. 6(2), pages 1-11, May.
    16. Yajing Huang & Taoxiong Liu, 2023. "Diversification and Systemic Risk of Networks Holding Common Assets," Computational Economics, Springer;Society for Computational Economics, vol. 61(1), pages 341-388, January.
    17. Paul Glasserman & Peyton Young, 2015. "Contagion in Financial Networks," Economics Series Working Papers 764, University of Oxford, Department of Economics.
    18. Jose Fique, 2016. "A Microfounded Design of Interconnectedness-Based Macroprudential Policy," Staff Working Papers 16-6, Bank of Canada.
    19. Navarro, Noemí & Tran, Dan H., 2018. "Shock Diffusion in Regular Networks: The Role of Transitive Cycles," MPRA Paper 86267, University Library of Munich, Germany.
    20. Peter Grundke, 2019. "Ranking consistency of systemic risk measures: a simulation-based analysis in a banking network model," Review of Quantitative Finance and Accounting, Springer, vol. 52(4), pages 953-990, May.

    More about this item

    Keywords

    Financial network; Contagion; Interconnectedness; Diversification; Bank capital;
    All these keywords.

    JEL classification:

    • G01 - Financial Economics - - General - - - Financial Crises
    • G21 - Financial Economics - - Financial Institutions and Services - - - Banks; Other Depository Institutions; Micro Finance Institutions; Mortgages

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:finsta:v:61:y:2022:i:c:s1572308922000432. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/jfstabil .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.