27 January 2014

A Dynamic Stochastic Network Model of the Unsecured Interbank Lending Market

Research into the interbank lending market suggests that policies reducing credit risk uncertainty might play an important role in fostering interbank lending and in re-establishing an active interbank market.

The global financial crisis of 2007-2008 highlighted again the crucial role of interbank lending markets for the financial system and the entire economy. Particularly, after the September 2008 fall of Lehman, dramatic increases in perceived counterparty risk led to severe distress of unsecured interbank markets. As a result, monetary policy implementation was hampered and credit supply to the non-financial sector dropped substantially with adverse consequences for both the financial sector and the real economy. In order to avoid these affects, central banks intervened by injecting additional liquidity in the banking sector  and adjusting their monetary policy instruments, becoming the intermediary for large parts of the money market during the crisis.

This experience further stimulated the debate about the organisational structure of interbank markets, in particular if the current decentralised market should be replaced by a system with a central counterparty. This paper, “A Dynamic Stochastic Network Model of the Unsecured Interbank Lending Market”, contributes to this debate by introducing and estimating a micro-founded structural dynamic stochastic network model to analyse observed cross-sectional and inter-temporal variation in interbank credit availability and conditions. The key economic concept underlying the model is that of asymmetric information about counterparty risk and liquidity conditions elsewhere in the market.

by Falk Bräuning, Francisco Blasques, Iman van Lelyveld

  • De Nederlandsche Bank
  • VU University Amsterdam