Do Banks Change Their Liquidity Ratios Based on Network Characteristics?

Abstract By applying interbank network simulation, this paper investigates the impact of interbank network topology on bank liquidity ratios. Whereas regulators have put more emphasis on liquidity requirements since the global financial crisis of 2007–2008, how differently shaped interbank networks affect individual bank liquidity behavior remains an open issue. We look at how banks' interconnectedness within interbank loan and deposit networks affects their decisions to hold more or less liquidity during normal times and distress times. Our sample consists of commercial, investment, and real estate and mortgage banks in 28 European countries and allows us to differentiate large and small networks. Our results show that accounting for bank connections within a network is important to understand how banks set their liquidity ratios. Our findings have critical implications for the implementation of Basel III liquidity requirements and bank supervision more generally.