Centrality-based Capital Allocations
This paper looks at the effect of capital rules on a banking system that is connected through correlated credit exposures and interbank lending. Keeping total capital in the system constant, the reallocation rules, which combine individual bank characteristics and interconnectivity measures of interbank lending, are to minimize a measure of systemwide losses. Using the detailed German Credit Register for estimation, we find that capital rules based on eigenvectors dominate any other centrality measure, saving about 15 percent in expected bankruptcy costs.
Key words: interbank connectivity, credit exposures, capital requirements, banking system, bank contagion, network centrality measure, bankruptcy costs, systemic risk.
JEL Classification: G21, G28, C15, C81.