Insights in European Interbank Network Contagion

Purpose – We analyse the importance of regulatory requirements and interbank connections to financial stability by looking at a large number of European and UK banks.Design/Methodology – We model interbank contagion using insights from the Susceptible Infected Recovered model. We construct scale-free networks with preferential attachment and growth, applying simulated interbank data to capture the size and scale of connections in the network. We proceed to shock these networks per country and we perform Monte Carlo simulations to calculate mean total losses and duration of infection. Finally, we examine the regulatory requirement effects of contagion in terms of Core Tier 1 Capital Ratios for affected banking systems.Findings – We find that shocks in smaller banking systems may cause smaller overall losses but tend to persist longer, leading to important policy implications for crisis containment.Originality – We infer the interbank domestic and cross border exposures of banks employing the RAS algorithm. We use an extend sample of 169 European banks, that also captures effects on the UK as well as the Eurozone interbank market. Finally, we provide evidence of the effects of contagion on each bank, allowing for bank heterogeneity by comparing the bank’s relative financial strength to the strength of the contagion that is modelled by the number and the volume of bilateral connections.