The Implications of Financial Network Architecture on the Stability of a Banking System

Sammanfattning: The structure of interbank connections affects financial system's resilience to shocks. This thesis determines the implications of network's architecture on stability of a banking system. A framework for structural analysis established in Elliott, Golub and Jackson (2014) is applied to the financial network model from Gourieroux, Heam and Monfort (2012) in order to examine performance of various network structures under two shock scenarios. The model used in the present research is calibrated to match data for a Swedish banking system (at the end of 2016). The results suggest that under an idiosyncratic shock regime, a mid-range level of diversification creates the most prone to default environment as banks are exposed to a significant propagation risk due to a bankruptcy of individual institutions, while a complete network structure shows good resilience. However, under a systemic shock regime, the complete network structure is the most susceptible to contagion. These findings support claims that diversified networks exhibit robust-yet-fragile tendencies, as concluded in Gai and Kapadia (2010).