Cahier 2016-13

Title:(In)Efficient Interbank Networks
Abstract:We study the optimality and the (decentralized) formation of an interbank network. Banks can offer higher expected returns to depositors by establishing connections in the network. However, banks have an incentive to gamble with depositors' money if not sufficiently capitalized. The bankruptcy of a bank negatively affects the banks connected to it (counterparty risk). We show that both the efficient network and the decentralized one are characterized by a core-periphery structure. Nevertheless, when bank capital transfers are not possible, the two network structures coincide only if counterparty risk is sufficiently low. Otherwise, the decentralized network is under-connected as compared to the optimal one. Finally, we show that bank capital transfers do not avoid the formation of inefficient networks.
Keyword(s):Interbank Network, Core-periphery, Liquidity Coinsurance, Counterparty Risk
JEL Class.:D85, G21

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