Network theory to strengthen the banking system

Dec 09, 2013

Since the beginning of the financial crises that erupted in 2008, numerous governments have injected public funds into the banking system in order to prevent the failure of some entities and avoid the collective collapse of the system itself. Furthermore, to strengthen the robustness of the banking system, central banks increase the reserve capital requirements, that is, the percentage of money that banks must hold, and not loan out. "This cash ratio has been uniformly applied to all of the firms, without taking into account which banks are the most important from a systemic perspective, and nothing has been done about the relationship between entities to reform the network and make it more resistant to a financial shock", explains Anxo Sánchez, of UC3M's Interdisciplinary Complex Systems Group.

The study, which recently appeared in the journal PLoS ONE, includes a systemic analysis of the way in which the structure of financial connections affects the spread of economic crises, taking into account changes in several variables simultaneously. This way, rather than evaluating the volume of business and strength of each bank separately, the study looks at the way in which one entity influences the health of the entire network. Following the ecosystem analogy, it would be somewhat similar to analyzing how the extinction of one species would affect the food chain and the viability of the natural surroundings. In fact, this study is part of a research project in which the robustness of economic networks and ecological networks are compared. 

Banking epidemiology

According to the actual data on corporate networks that were analyzed by the authors, among whom there is also a researcher from the University College London, the current financial system may be very sensitive to small structural changes. The conclusion is that work should be done not only on the entities themselves, but also on the relationships between them. "A very good way of increasing the robustness of the network and thus prevent a failure or 'shock' from spreading throughout the entire system might be to modify the links between the entities," points out Professor Sánchez. To do this "some interbank loans could be restructured, reorganizing the network in subgroups, because asking the banks to increase their reserves may not be as useful as regulators currently believe. Depending on the type of entity it affects, the measure may even be completely useless," he states.

According to the researchers, these results offer a new vision and arguments for the politicians in charge so that they can focus on, not only the capital requirements that are directed at the nodes, but also on the connection between the firms that make up the financial network. To put this into practice, however, it would be necessary to have a precise knowledge of the data and the relationships between the entities of interest, in addition to the processes defined in the connections (interbank loans, belonging to one company or another, joint properties, etc.) "In many cases this is very difficult, if not impossible, for reasons of confidentiality, although the central banks could actually apply the methodology that we propose and study the applicability of the policies we suggest, given that they know every last detail of the system's data," says Professor Sánchez. 

Explore further: London-based banks simulate giant cyber-attack

More information: "Towards a Proper Assignment of Systemic Risk: The Combined Roles of Network Topology and Shock Characteristics." Lasse Loepfe, Antonio Cabrales, Angel Sánchez PLoS ONE 8(10): e77526 (17 October 2013).DOI: 10.1371/journal.pone.0077526

add to favorites email to friend print save as pdf

Related Stories

London-based banks simulate giant cyber-attack

Nov 12, 2013

Dozens of London-based banks joined other financial institutions in the capital on Tuesday for a giant exercise to test their defences against a cyber-attack, officials said.

Information transmission a good predictor of credit crisis

May 31, 2013

The recent credit crisis was preceded by a sharp increase in the transmission of information in the largest derivatives market. Such transmissions can therefore serve as indicators for the instability of the market. A team ...

Recommended for you

Which foods may cost you more due to Calif. drought

Apr 17, 2014

With California experiencing one of its worst droughts on record, grocery shoppers across the country can expect to see a short supply of certain fruits and vegetables in stores, and to pay higher prices ...

Performance measures for CEOs vary greatly, study finds

Apr 16, 2014

As companies file their annual proxy statements with the U.S. Securities and Exchange Commission (SEC) this spring, a new study by Rice University and Cornell University shows just how S&P 500 companies have ...

Investment helps keep transport up to speed

Apr 16, 2014

Greater investment in education and training for employees will be required to meet the future needs of the transport and logistics industry, according to recent reports by Monash University researchers.

User comments : 0

More news stories

Clippers and coiners in 16th-century England

In 2017 a new £1 coin will appear in our pockets with a design extremely difficult to forge. In the mid-16th century, Elizabeth I's government came up with a series of measures to deter "divers evil persons" ...

Making graphene in your kitchen

Graphene has been touted as a wonder material—the world's thinnest substance, but super-strong. Now scientists say it is so easy to make you could produce some in your kitchen.