Domino Effects When Banks Hoard Liquidity: The French Network

40 Pages Posted: 12 Apr 2013

See all articles by Valère Fourel

Valère Fourel

Banque de France; Massachusetts Institute of Technology (MIT) - Sloan School of Management

Jean-Cyprien Heam

Banque de France

Dilyara Salakhova

Banque de France

Santiago Tavolaro

Independent

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

Fourel, Valère and Fourel, Valère and Heam, Jean-Cyprien and Salakhova, Dilyara and Tavolaro, Santiago, Domino Effects When Banks Hoard Liquidity: The French Network (April 2013). Banque de France Working Paper No. 432, Available at SSRN: https://ssrn.com/abstract=2248624 or http://dx.doi.org/10.2139/ssrn.2248624

Valère Fourel (Contact Author)

Banque de France ( email )

Paris
France

Massachusetts Institute of Technology (MIT) - Sloan School of Management ( email )

100 Main Street
E62-416
Cambridge, MA 02142
United States

Jean-Cyprien Heam

Banque de France ( email )

Paris
France

Dilyara Salakhova

Banque de France ( email )

Paris
France

Santiago Tavolaro

Independent

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