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Systemic risk in banking ecosystems

Abstract

In the run-up to the recent financial crisis, an increasingly elaborate set of financial instruments emerged, intended to optimize returns to individual institutions with seemingly minimal risk. Essentially no attention was given to their possible effects on the stability of the system as a whole. Drawing analogies with the dynamics of ecological food webs and with networks within which infectious diseases spread, we explore the interplay between complexity and stability in deliberately simplified models of financial networks. We suggest some policy lessons that can be drawn from such models, with the explicit aim of minimizing systemic risk.

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Figure 1: Notional principal value of outstanding derivative contracts, as recorded at year end.
Figure 2: Discontinuous transition to instability of derivatives as complexity increases.
Figure 3: Schematic model for a node in the interbank network.
Figure 4: Domains of interbank lending.
Figure 5: Recent rise in the size and concentration of the United States financial system.

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Acknowledgements

We are indebted to colleagues (particularly S. Kapadia, N. Arinaminpathy and G. Sugihara), who made many helpful comments and constructive criticisms.

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Correspondence to Robert M. May.

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The authors declare no competing financial interests.

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Haldane, A., May, R. Systemic risk in banking ecosystems. Nature 469, 351–355 (2011). https://doi.org/10.1038/nature09659

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