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สถาบันวิจัยเศรษฐกิจป๋วย อึ๊งภากรณ์
Puey Ungphakorn
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Call for Papers: PIER Research Workshop 2025
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Discussion Paperdp
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Year
2025
2024
2023
2022
...
15 March 2022
20221647302400000
No. 175

Optimal Liquidity Control and Systemic Risk in an Interbank Network with Liquidity Shocks and Regime-dependent Interconnectedness

Abstract

We propose a novel interbank network model in which banks face systemic liquidity shocks, flight-to-quality liquidity flows, and collapses of the interbank network during crises, and study their impacts on the optimal liquidity control and the systemic risk of the interbank network. We find that banks respond to negative shocks by holding positive precautionary liquidity, but once the shock size is sufficiently large, the benefit of precautionary liquidity reduces, and banks lower their precautionary liquidity. Lending (borrowing) banks also hold positive (negative) interbank liquidity provision. Banks hold more provision for more interconnected networks, but when the network is too interconnected, it is too costly to hold large provision, causing banks to lower the provision. On the contrary, a higher degree of the flight-to-quality effect tends to make banks act more aggressively on both precautionary liquidity and interbank provision. As a result, the systemic risk tends to increase in the size of the negative shock, but is quite insensitive to the degree of the flight-to-quality effect. Our analysis shows that the systemic risk increases if the interbank market collapses or becomes too interconnected during crises. Rewards and penalties from regulators can help reduce the systemic risk, but they come with a cost and have different implications on the banks' optimal policies.

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JEL: C44C73D81D85E02G01G21G28L14
Tags: liquidity shockinterbank interconnectednessflight-to-qualitysystemic riskprecautionary liquidityinterbank liquidity provisionregime switchingstochastic control
The views expressed in this workshop do not necessarily reflect the views of the Puey Ungphakorn Institute for Economic Research or the Bank of Thailand.
Chotipong Charoensom
Chotipong Charoensom
Bank of Thailand
Thaisiri Watewai
Thaisiri Watewai
Chulalongkorn University

Puey Ungphakorn Institute for Economic Research

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Phone: 0-2283-6066

Email: pier@bot.or.th

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