Domino Effects When Banks Hoard Liquidity: The French Network
40 Pages Posted: 12 Apr 2013
Date Written: April 2013
Abstract
We investigate the consequences of banks' liquidity hoarding behavior for the stability of the financial system proposing a new model of banking contagion through two channels, bilateral exposures and funding shortage. Inspired by the key role of liquidity hoarding in the 2007-2009 financial crisis, we incorporate banks' hoarding behavior in a standard Iterative Default Cascade algorithm to compute the propagation of a common market shock through a banking system. In addition to potential solvency contagion, a market shock leads to banks’ liquidity hoarding that may generate problems of short-term funding for other banks. As an empirical exercise, we apply this model to the French banking system. Relying on data on bank’s bilateral exposures collected by the French Prudential Supervisor Authority, the French banking sector appears resilient to the combination of an initial market shock (losses on marked-to-market assets) and of the resulting solvency and liquidity contagion. Gauging the relative weights in the total loss of the various factors, the model sheds light on the complexity of liquidity hoarding effects.
Keywords: Liquidity hoarding, solvency and funding contagion, financial networks, systemic risk
JEL Classification: G01, G21, G28
Suggested Citation: Suggested Citation
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