Interbank Lending, Reserve Requirements and Systemic Risk

We simulate interbank lending. Each bank faces fluctuations in deposits and stochastic investment opportunities which mature with delay. This creates the risk of liquidity shortages. An interbank market lets participants pool this risk but also creates the potential for one bank's crisis to propagate through the system. We study banking systems with homogeneous banks, as well as systems in which banks are heterogeneous. With homogeneous banks, an interbank market unambiguously stabilises the system. With heterogeneity, knock-on effects become possible but the stabilising role of interbank lending remains so that the interbank market can play an ambiguous role.