(Research Question) The interbank market offers banks the possibility to exchange liquidity without having to rely on other sources, such as central banks or retail deposits. While this is in general beneficial to the financial system, it fosters the connectedness and the synchronization of banks, thus making them more vulnerable. This paper aims at quantifying the risks borne by the system, the risks borne by single banks and the risks emitted from single banks. For this purpose, the interbank network structure is analyzed and a simulation method is applied to elicit the desired information. To show the functionality and implications of our framework, we apply it to the German interbank market as of end 2016.
(Contribution) We contribute to the literature by simulating distributions of possible events which allow to study the probability of arbitrary events, for example the probability of having a loss exceeding a certain threshold. Most studies in this strand of literature focus on deriving probabilities for particular events, which are all nested by our approach. Lastly, our frame- work further gives information about which banks emit the most risks through the interbank market, a widely-discussed concept often called “systemic relevance” in the literature.
(Results) We find that the examined portion of the German banking system appears generally resilient to domestic exogenous interbank shocks. Even if large or well connected banks default, the system can absorb the losses rather easily due to its sufficient capital buffers. For single institutions, however, we find indications for elevated vulnerabilities and the need for a close supervision.