Propagation of defaults in banking networks

Systemic risk refers to the possibility that the failure of a financial institution spreads to others threatening the integrity of the whole financial system. This MSc thesis is a study of the propagation of defaults trough interbank links. Using agent-based modeling we recreate the loss contagion process that takes place when a bank becomes insolvent and ceases operation due to an external shock. Changing the parameters of the model allows for the simulation of different scenarios. We find that the relationship between the net worth and the size of interbank exposures plays a key role in the shock transmission process. Moreover, we study the effect of asset liquidation. Our results show that the liquidation of interbank assets diminishes the number of defaults, whereas the liquidation of external assets has the opposite effect. Finally, we discuss the role of network topology, which basically determines banks sizes. As expected, we see that large banks have a more severe impact on the stability of the system than small banks.