Contagion and supervision of liquidity crisis in interbank markets: Based on the SIS network model

The transmission of the liquidity crisis across interbank lending markets has emerged as a primary concern for regulatory agencies. In this paper, we consider the nonlinear dynamic contagion and the regulatory scheme of liquidity crisis in the interbank lending network. We first propose a Susceptible–Infected–Susceptible epidemic network model to describe the dynamics of crisis contagion between banks. We find that complex interbank linkages and the heterogenous contagiousness and resilience of banks determine the equilibrium state of the system and the crisis outbreak trajectory of each group. We prove the positive effect of improving bank liquidity on mitigating the crisis outbreak. Next, we propose concrete intervention policies based on two widely used liquidity regulation approaches — cutting reserve requirements and repo operations. With the financial data of China’s banks from 2007 to 2021, we find that the liquidity crisis can be eliminated without intervention in 2021 in China due to nearly a decade of continued decrease in the reserve requirement ratios. We finally show that an unhealthy structure of interbank network can lead to a system where infection outpaces recovery. In this case, the effect of liquidity regulation is weak. The empirical results find that liquidity regulation is generally effective from 2013 to 2017, but weak from 2007 to 2010.