A financial network is a set of financial entities linked to each other through transactions. These links can be direct or through the ability to mediate. The purpose of creating a financial network is to improve the efficiency of the financial system. However, a financial network must be created carefully to ensure that it is working optimally.
The structure of a financial network is similar to that of a traditional banking system. There is a central country, and many countries within a financial system belong to it. A large financial system has the potential to transmit shocks across the whole system. For example, in the European Union, individual countries have relatively little impact on shock propagation within the financial network, but the Eurozone as a whole is susceptible to shocks. Another important development is the rising role of Asian countries, which increases the vulnerability of the network to shocks originating in China and Hong Kong SAR economies.
The complexity of the financial network leads to problems such as information asymmetries and collective moral hazard. In a complex financial network, the default probability of one institution depends on the default probabilities of other banks within the network. These problems increase the risk a financial institution takes and increase the risks in the system. The complexity of the financial network may also lead to issues such as implicit public subsidies.
