Rethinking Financial Stability: Challenges Arising from Financial Networkss Modular Scale-Free Architecture

Evidence from the main Colombian payment and settlement systems verifies that local financial networks have self-organized into a modular (i.e. clustered) scale-free (i.e. inhomogeneous) architecture that favors everyday robustness and performance in exchange for rare episodes of fragility but rapid evolution. Results concur with other real-world networks, and propose new insights and challenges for authorities contributing to financial stability. For instance, (i) traditional reductionist assumptions for modeling financial systems (e.g. homogeneity) may seriously mislead financial authorities’ efforts; (ii) the observed modular scale-free architecture tends to limit cascades and isolate feedbacks; (iii) carelessly reducing inhomogeneity by simply downsizing or dismantling systemically important financial institutions may backfire in the form of a less robust and more crisis-prone financial system; and (iv) financial authorities should understand and take advantage of the existing architecture by means of designing and implementing macro-prudential regulation and system-calibrated requirements.