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A functional perspective on financial networks

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Abstract

The financial sector is a critical component of any economic system, as it delivers key qualitative asset transformation services in terms of liquidity, maturity and volume. Although these functions could in principle be carried out separately by specialized actors, in the end it is their systemic co-evolution that determines how the aggregate economy performs and withstands disruptions. In this paper we argue that a functional perspective on financial intermediation can be usefully employed to investigate the functioning of financial networks. We do this in two steps. First, we use previously unreleased data to show that focusing on the economic functions performed over time by the different institutions exchanging funds in an interbank market can be informative, even if the underlying topological structure of their relations remains constant. Second, a set of alternative artificial histories are generated and stress-tested by using real data as a calibration base, with the aim of performing counterfactual welfare comparisons among different topological structures.

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Notes

  1. See, among others, Boss et al. (2004), Iori et al. (2006), Soramäki et al. (2007), Martinez-Jaramillo et al. (2014), Bargigli et al. (2015).

  2. Nier et al. (2007), Gai et al. (2011), Battiston et al. (2012), Krause and Giansante (2012), Anand et al. (2013) and Gaffeo and Molinari (2015, 2016).

  3. Within the Italian cooperative credit system, comprising 364 intermediaries at the end of 2015, it is possible to distinguish between rural banks, cooperative credit banks and Raiffeisen banks. All of them are mutual not-for-profit cooperatives, operating with a small number of branches (the average for the system in 2015 was 8) on local markets. In what follows we use the expression “cooperative credit banks” as a shortcut to comprise them all.

  4. An exception is represented by Aguiar et al. (2014).

  5. The Italian law admits several alternative governance models for banks. In addition to cooperative credit banks, bank intermediaries can be chartered as Banche Popolari (cooperative banks with somehow lighter constraints on the fraction of loans deliverable to non-member borrowers and the distribution of dividends, and the possibility to go public), Casse di Risparmio (Savings and Loan associations, typically coming with the form of joint stock companies) and standard shareholder banks. In what follows we will group them all under the heading “shareholder banks”.

  6. Non-overnight flows comprise all transactions with maturities ranging from 2 days to 36 months.

  7. See, among the others, Iori et al. (2008), Finger et al. (2013), Hatzopoulos et al. (2015) and Mancini et al. (2016).

  8. Silva et al. (2016) show that also the bank-level efficiency is affected by the structure of the interconnections linking financial intermediaries.

  9. If the hub is a deficit bank and the periphery is composed by one half of deficit and one half of surplus banks, 50% of the links are misbehaved. A similar result holds if the hub is a surplus bank.

  10. The calibration of the non-weighted leverage ratio is the same as in Gai and Kapadia (2010). The relative size of the interbank market (16 percent) is in line with in Italy, as shown by Manna and Iazzetta (2009).

  11. More in detail, we assumed that CC and BoI could not be directly shocked as they simply do not accept deposits from the general public.

  12. Of course, there is no guarantee that a decentralized system would be able to actually provide this level of liquidity. We do not investigate this. Given this assumption, our analysis thus provides a best-case scenario for a decentralized system.

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Acknowledgements

This version of the paper has greatly benefited from the very constructive comments of two anonymous referees. We are grateful to Cassa Centrale Banca, in particular to Thomas Franchini, for the data used in this study, and to Seung Hwan Lee for having shared with us his codes. We also wish to thank for helpful discussions and suggestions Leonardo Bargigli, Pietro Battiston, Michele Catalano, Giovanni Cerulli, Giorgio Di Giorgio, Matteo Falagiarda, Giovanni Ferri, Guido Germano, Simone Giansante, Roberto Tamborini and the audiences at the ECB - Monetary Analysis Division (Frankfurt am Main, Germany), the 25th International Rome Conference on Money, Banking and Finance - Roma Tre University, the 57th Annual Conference of the Italian Economic Association, Bocconi University (Milano- Italy), the IWCEE15 - International Workshop on Computational Economics and Econometrics, Rome (Italy), the 20th WEHIA Workshop - SKEMA Business School, Sophia Antipolis (France) and the 5th International Workshop on Cooperative Finance and Sustainable Development, University of Trento (Italy). Massimo Molinari gratefully acknowledges the financial support of Fondazione Caritro. Part of the research undertaken for this paper was done when Massimo Molinari was at Sapienza University of Rome and supported by the funding grant 278/2016 from the same institution. The opinions expressed herein are those of the authors and do not necessarily reflect the views of the Bank of Italy or the Eurosystem.

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  1. Department of Economics and Management, University of Trento, Via Inama 5, 38100, Trento, Italy

    Edoardo Gaffeo

  2. Market Operations Directorate, Bank of Italy, Via Nazionale 91, 00184, Rome, Italy

    Massimo Molinari

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  1. Edoardo Gaffeo
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Correspondence to Massimo Molinari.

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Gaffeo, E., Molinari, M. A functional perspective on financial networks. J Econ Interact Coord 13, 51–79 (2018). https://doi.org/10.1007/s11403-017-0210-7

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