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The interbank market is considered one of the most important channels 6 of contagion. Its network representation, where banks and claims/obligations are 7 represented by nodes and links (respectively), has received a lot of attention in 8 the recent theoretical and empirical literature, for assessing systemic risk and 9 identifying systematically important financial institutions. Different types of links, 10 for example in terms of maturity and collateralization of the claim/obligation, can 11 be established between financial institutions. Therefore a natural representation of 12 the interbank structure which takes into account more features of the market, is 13 a multiplex, where each layer is associated with a type of link. In this paper we 14 review the empirical structure of the multiplex and the theoretical consequences of 15 this representation. We also investigate the betweenness and eigenvector centrality 16 of a bank in the network, comparing its centrality properties across different layers 17 and with Maximum Entropy null models.

The interbank market is considered one of the most important channels of contagion. Its network representation, where banks and claims/obligations are represented by nodes and links (respectively), has received a lot of attention in the recent theoretical and empirical literature, for assessing systemic risk and identifying systematically important financial institutions. Different types of links, for example in terms of maturity and collateralization of the claim/obligation, can be established between financial institutions. Therefore a natural representation of the interbank structure which takes into account more features of the market, is a multiplex, where each layer is associated with a type of link. In this paper we review the empirical structure of the multiplex and the theoretical consequences of this representation. We also investigate the betweenness and eigenvector centrality of a bank in the network, comparing its centrality properties across different layers and with Maximum Entropy null models., To appear in the book "Interconnected Networks", A. Garas e F. Schweitzer (eds.), Springer Complexity Series

This special issue of Quantitative Finance collects eight papers on the relation between interlinkages and systemic risk. The papers cover several types of interlinkages and follow different approaches, from agent-based modelling to empirical investigation of large and sometimes confidential data. The special issue collects some of the contributions presented at the international workshop‘Interlinkages and systemic risk ’ , which took place in Ancona (Italy) on 4 – 5 July 2013. The workshop, organized within the research project‘. New tools in the credit network modeling with agents ’ heterogeneity ’ funded by the Institute for New Economic Thinking, was attended by a balanced mix of scholars from academia and economists from central banks and regulatory authorities.

We build a two-period model a la Holmstrom and Tirole (1998) in which bankers have access to a shadow banking technology which allows to liquefy partially illiquid investment projects (e.g. mortgages) and to manufacture shadow collateral (e.g. MBS). We study the bankers' security design of shadow collateral. By seeking simple shadow banking, bankers design shadow collateral which is liquid in all states of nature; in this case, the technology also provides liquidity insurance against aggregate shocks (crisis). Conversely, with complex shadow banking, shadow collateral is designed to be extremely liquid in states without ag- gregate shocks, thereby boosting bankers' leverage, but illiquid in a crisis. We frame this leverage-insurance choice into the modern nancial ecosystem bankers inhabit, characterized by two structural developments. First, the rise of institutional cash pools which manage large cash balances. Their demand for parking space is accommodated by sovereign bonds and shadow collateral. Second, the proliferation of balance sheets with asset-liability mismatches (ALMs), like those of insurance companies and pension funds; these entities have liabilities in xed nominal amount and, in a low yield environment, seek to allocate funds to bankers which deliver leverage-enhanced returns. We show that when the demand for parking space from cash pools - as compared to the supply of sovereign bonds - and the demand for returns from entities with ALMs are high, complex shadow banking is the competitive equilibrium outcome and the economy is prone to massive deleveraging in the case of aggregate shocks. The paper has several implications in terms of central banks' policy (e.g. Reverse Repo Programs), regulation (capital and liquidity) and, more generally, policies aimed at tackling the two structural developments.

The interbank market has a natural multiplex network representation. We employ a unique database of supervisory reports of Italian banks to the Banca d'Italia that includes all bilateral exposures broken down by maturity and by the secured and unsecured nature of the contract. We find that layers have different topological properties and persistence over time. The presence of a link in a layer is not a good predictor of the presence of the same link in other layers. Maximum entropy models reveal different unexpected substructures, such as network motifs, in different layers. Using the total interbank network or focusing on a specific layer as representative of the other layers provides a poor representation of interlinkages in the interbank market and could lead to biased estimation of systemic risk., 41 pages, 8 figures, 10 tables

The paper shows that the time-consistent policy of public bailout affects the private liquidity choice of banks in several ways. First, banks anticipate public support in a liquidity crisis and seek large and socially inefficient exposures to shadow banking, defined as a privately costly technology that allows banks to liquefy their balance sheet. In this way, banks reduce their liquidity need in terms of expensive sovereign debt securities and boost leverage. Second, the liquidity choice becomes risky even with respect to the sovereign debt securities portfolio allocation: banks protected by guarantees from a healthy risk-free government load with cheaper non-domestic risky sovereign debt as they expect to extract public support even in the presence of some sovereign default. Finally, the propensity to expose to shadow banking is procyclical. These insights have important implications in terms of regulation. Global reforms that curb banks' ability to extract free insurance from the public bailout would promote efficiency. Policymakers should resort to a full-blown ban on shadow banking only if the previous goal is unattainable.

Economic theory argues that developed financial systems foster economic growth by promoting efficiency in the allocation of resources to productive units. However, the evidence from the flow of funds in the last 15 years suggests that in countries with booming financial sectors innovations in intermediation activity, rather than influencing firms’ capital structure, have promoted self-referential dynamics, as the overall expansion in size has been mainly due to the surge in claims and obligations between financial firms. The evidence of the increased interconnectedness within the financial system has several implications for financial stability.

We use an incentive model in which improvements to fundamentals boost the ability of leveraged financial firms (banks) to expand the balance sheet (as in Adrian and Shin 2010). The rise in asset prices due to the amplified response of procyclical systems distorts bankers' incentives in providing (costly and non observable) monitoring effort. On the one hand, the fundamental value of assets positively affects the optimal effort of the banker, thus allowing supervisory authorities to relax incentive-compatible capital requirements and boosting asset demand and prices. On the other hand, in a macro perspective, high prices positively affect the banker's payoff in the bad state of asset liquidation (via asset prices), jeopardizing incentives. This type of externality follows from a purely “macro” phenomenon a la Borio (2003) and should be taken into account by the regulatory authority in designing capital requirements. In procyclical and advanced (low agency costs and highly liquid) financial systems, incentive compatibility requires a higher capital requirement in the face of an improvement to fundamentals. Our results provide a theoretical foundation to the countercyclical buffer provided for by the Basel Committee.