Contagion of bank failures through the interbank network in Argentina
By
INTERBANK NETWORK OF PRIVATE ENTITIES IN 1998 - ONLY LINKS FROM FAILING BANKS. The network only with links originating in failing banks, that is, interbank loans where the borrower eventually fails. Among the 23 failing banks, 16 of them have a direct link to another failing one (approximately 70%), suggesting the presence of a contagion effect: the failure of a bank raises the probability of neighboring banks failing as well. Many failing bank were borrowing from the same non-failing bank.s are also indirect path among failing banks through a non-fail bank.
Abstract
Capital regulation on banks aims to reduce the probability of failures. In theory, the effect of capital buffers in preventing failures could depend on the linkages among financial institutions. These linkages are nevertheless usually omitted in empirical models. I study the effectiveness of capital regulation in preventing failures using a spatial autoregressive probit model, which accommodates links among banks and feedback effects. I study the Argentinian banking crisis of 2001 for which I build the complete interbank network. By allowing linkages between banks, estimates from the spatial model show that capital regulation is 50% less effective than estimates of a model in which banks are not interconnected.