Visualizing TBTF: The Hub And Spoke Representation Of Modern "Scale Free" Banking

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In a few moments we will post a critical analysis by David Korowicz, titled Trade-Off: Financial System Supply-Chain Cross- Contagion: a study in global systemic collapse, arguably one of the best big picture overviews of the New Normal in systemic complexity, which considers the "relationship between a global systemic banking, monetary and solvency crisis and its implications for the real-time flow of goods and services in the globalised economy" and specifically looks at how various "what if" scenarios can propagate through a Just In Time world in which virtually everything is connected, and in which even a modest breakdown in one daisy-chain can lead to uncontrolled systemic collapse via the trade pathways more than ever reliant on solvency, sound money and bank intermediation. In summary, Korowicz shows why we as a society, are now consistently on "the edge."

But before that we wanted to present schematically, and narratively, one of the more important topics of the past several years, namely the "scale-free" nature of modern banking, in which very few Hub financial institutions impact an exponentially increasing number of Spokes, a phenomenon which "opened up the possibility of 'too big to fail' and 'too big to save' banks, that is, a small group of banks that were 'hubs' of the global banking system. Upon this small number of super-connected banks stand the operations of lots of small ones." Of course, this phenomenon will not be news to anyone who has read either Taleb's works on "non-scalability" and Soros' philosophical ruminations on "reflexivity." Regardless, here it is in its full visual glory.

Korowicz describes the relationship map as follows:

The major banks hubs of the international financial network show high levels of connectivity and interdependence. The links are weighted to represent the strongest relations between banks. The colours represent different geographic areas, European Union  (red), North America (blue), other countries (green).

He goes on:

Prior to the beginning of the financial crisis, risk management by regulators was focussed on individual banks. In addition it was common to hear how increased interconnection and integration between banks reduced systemic risk by dispersing individual bank risk over the whole system. The crisis prompted a wave of studies, drawing particularly upon ecology, emphasising how the structure between banks could increase systemic risk.


This included collective effects like herding, in which financial networks enabled imitative strategies in the search for yield, or transmitted collective euphoria or panic. They also showed how deregulation and connectivity had removed 'circuit-breakers' in financial systems such as the integration of retail banks into merchant banks trading on their own account. The effectiveness of fire-breaks and the vaccination of super-spreaders show how 'modularity' can inhibit contagion in natural systems. Indeed, the 'fire- break' of the nonfree traded Chinese Yuan probably stopped the 1997 Asian financial crisis from being far more serious.


Further the nature of the connections between banks was explored. Each bank was not connected at random to other banks, rather a very small number of large banks were highly connected with lots of other banks, who had few connections to each other. These arrangements are sometimes known as scale-free networks. Preferential attachment is a way of generating such scale-free networks - big banks have greater economies of scale and bargaining power, so can attract more business than their smaller rivals with better deals or market crowd-out, thus generating even greater economies of scale and so on.


For example, when the Federal Reserve Bank of New York commissioned a study of the structure of the inter-bank payment flows within the US Fedwire system they found remarkable levels of concentration. Looking at 7,000 transfers between 5,000 banks on an average day, they found 75% of payment flows involved less than 0.1% of the banks and 0.3% of linkages.


While this type of scale-free structure can reduce local risk, it can also help to displace and concentrate large-scale systemic risk. A random failure in a scale-free network is likely to affect a node of low connectivity, with small implications. However, the failure of a hub node has a disproportionate impact, especially if those hub nodes have high connectivity to each other. This concentration opened up the possibility of 'too big to fail' and 'too big to save' banks, that is, a small group of banks that were 'hubs' of the global banking system. Upon this small number of super-connected banks stand the operations of lots of small ones.


Thus we see the primary financial monetary keystone-hub with little or no redundancy, underpinned by a secondary banking  system that comprises high, but not quite as high levels of concentrating hubs.

As a reminder, this is merely a tiny preamble into what will be a far more extensive overview of the complexities of the modern world in which finance, "sound money", economics, trade, and of course solvency are tightly woven into a fabric that defines our everyday lives, and in which the smallest shock has the potential to propagate through the system in unpredictable, Lorenzian patterns with massive avalanche-like follow through aftereffects.