North American Journal of Economics and Finance 33 (2015) 149–166 Contents lists available at ScienceDirect North American Journal of Economics and Finance Does the bank risk concentration freeze the interbank system? Marcella Lucchetta ∗ Universita’ Ca’ Foscari di Venezia, Dipartimento di Economia, Italy a r t i c l e i n f o Article history: Received 19 May 2014 Received in revised form 2 April 2015 Accepted 2 April 2015 Available online 17 April 2015 Keywords: Interbank system Risks concentration a b s t r a c t Probably, one test of the stability of the banking system is to evalu- ate how risky assets are distributed across banks’ portfolios and the implications for the contagion via interbank relations. This paper explores theoretically a bank sector with risks concentration and the functioning of interbank markets. It employs a simple model where banks are exposed to both credit and liquidity risk that suddenly correlate over the business cycle. We show that risk con- centration makes interbank market breakdowns more likely and welfare monotonically decreases in risk concentration. © 2015 Elsevier Inc. All rights reserved. 1. Introduction A key feature of the 2007–2008 financial crisis has been the disruption and prolonged malfunc- tioning of interbank markets (see, e.g. Acharya & Merrouche, 2013; Afonso, Kovner, & Schoar, 2011; Ciccarelli, Maddaloni, & Peydró, 2013; Heider, Hoerova, & Holthausen, 2010 1 ) sometimes related to the interbank network structure (Georg, 2013 2 ). This has come as a surprise to most observers, since inter- bank markets have been functioning smoothly historically, even in the face of severe stress episodes ∗ Tel.: +39 3356955599. E-mail address: lucchett@unive.it 1 Ciccarelli et al. (2013) find that financial intermediaries are extremely fragile in the EU. The ECB effectively partly substituted the interbank market and, in turn, induced a subsequent softening of lending conditions. 2 Georg (2013) shows that networks with the central bank that intervene, solving market incompleteness, are more stable than random networks. http://dx.doi.org/10.1016/j.najef.2015.04.002 1062-9408/© 2015 Elsevier Inc. All rights reserved.