Resilience of the Interbank Network to Shocks and Optimal Bail-Out Strategy: Advantages of "Tiered" Banking Systems

This paper studies systemic risk and the scale of systemic breakdown in the frequently observed tiered banking system. The banking network is constructed from a number of banks which are linked by interbank exposures with a certain predefined probability. In this framework, the tiered structure is represented either by a network with negative correlation in connectivity of neighboring banks, or alternatively, by a network with a scale-free distribution of connectivity. The main findings of the paper highlight the advantages of tiering in terms of both the resilience of the banking network to systemic shocks and the extent of necessary government intervention should a crisis evolve.