Contagion in the interbank market and its determinants

Carrying out interbank contagion simulations for the German banking sector for the period from the first quarter of 2008 to the second quarter of 2011, we obtain the following results: (i) The system becomes less vulnerable to direct interbank contagion over time. (ii) The loss distribution for each point in time can be condensed into one indicator, the expected number of failures, without much loss of information. (iii) Important determinants of this indicator are the banks’ capital, their interbank lending in the system, the loss given default and how equal banks spread their claims among other banks.

► We carry out interbank contagion simulations for the German banking system.
► Unique data set with bilateral exposures (on and off balance), 14 quarters.
► Danger of interbank contagion goes down.
► Expected number of failing banks is a suitable indicator.
► Determinants: capital, interbank lending, LGD, and entropy of the exposures.