Bank interconnectedness and financial stability: The role of bank capital
Journal
Journal of Financial Stability
Journal Volume
61
Date Issued
2022
Author(s)
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. © 2022 Elsevier B.V.
Subjects
Bank capital; Contagion; Diversification; Financial network; Interconnectedness
Type
journal article