How the interbank market becomes systemically dangerous: an agent-based network model of financial distress propagation

Assessing the stability of economic systems is a fundamental research fo= cus in economics that has become increasingly interdisciplinary in the curr= ently troubled economic climate. In particular, much attention has been dev= oted to the interbank lending market as an important diffusion channel for = financial distress during the recent crisis. In this paper, we study the st= ability of the interbank market to exogenous shocks using an agent-based ne= twork framework. Our model encompasses several ingredients that have been r= ecognized in the literature as procyclical triggers of financial distress i= n the banking system: credit and liquidity shocks through bilateral exposur= es, liquidity hoarding due to counterparty creditworthiness deterioration, = target leveraging policies and fire-sale spillovers. However, we exclude th= e possibility of central authorities intervention. We implement this framew= ork on a data set of 183 European banks that were publicly traded between 2= 004 and 2013. We document the extreme fragility of the interbank lending ma= rket up to 2008, when a systemic crisis leads to total depletion of market = equity with an increasing speed of market collapse. After 2008, the system = is more resilient to systemic events in terms of residual market equity. Ho= wever, the speed at which a crisis breaks out reaches a new maximum in 2011= , and it never returns to the values observed before 2007. Our analysis poi= nts to the key role that crisis outbreak speed plays: it sets the maximum d= elay for central authorities intervention to be effective.