Bank Avalanche Model

Throughout history, financial institutions have played an important role in linking borrowers with lenders.  Some loans go bad and some are profitable. Some banks fail and others are successful.  When a bank with a large footprint fails, however, this can cause other banks to fail and lead to systemic problems in the financial system. The Bank Avalanche Model gives a dynamic representation of the interconnectedness of the financial system.

The model has non-financial transactors (NFTs), banks, and AIG that exchange financial claims with each other according to the following set of rules.

NFTs make the following decisions every period:

• Make deposits into banks.
• Apply for a loan with a specific bank.
• Repay an existing loan (if they have a loan).
• Default on an existing loan (if they have a loan).

Banks make the following decisions every period:

• Take deposits from NFTs.
• Meet the reserve requirements with deposits.
• Make loans to NFTs with money from deposits.
• Make euroloans to other banks (in the network) if deposits exceed reserves.
• Banks accept euroloans if they lack enough deposits in order to provide loans to their loan applicants.

AIG makes the following decisions every period:

• AIG is an insurance company that is connected to all banks and issues insurance in the form of credit default swaps (CDS) to banks.
• Banks sell a certain amount of CDS to AIG to insure their loans to NFTs.
• Banks purchase CDS from AIG.

The simulation ends and restarts when all agents in the system disappear.  An avalanche occurs when more than one bank fails at a time.  The model generates distributions bank life span, bank profitability, and avalanches per simulation.

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A quick review of the Bank Avalanche Model can be found here.