Bank ownership, financial segments and the measurement of systemic risk: An application of CoVaR

Abstract

The recent financial crisis has shown that the regulatory framework that has been formulated and implemented over the last twenty years under the Basel I and II agreements has relied excessively on the monitoring of individual financial institutions. It failed to capture the contribution of systemic risk, which is considered to be the risk that is the outcome of collective behaviour of financial institutions that have significant effects on the real economy. This paper investigates whether the increased presence of foreign banks which are listed on a national stock market has contributed to the increase in the systemic risk, in particular, after the financial crisis of 2007–2009. We examine the extent to which the distress of foreign banks contributes to systemic risk for the US. In addition using relevant data for the UK we investigate the extent to which distress within different sub-segments of the financial system, namely, the banking, insurance and other financial services industries contribute to systemic risk. We conduct our analysis with the CoVaR measure of systemic risk recently developed by Adrian and Brunnermeier (2011) using daily data for the period 2 January 2000 to 31 December 2012. Furthermore, we complement our analysis with the application of two tests, the significance and dominance tests, to provide a formal comparison of the relative contribution of either the domestic or foreign banks and/or each individual financial sector. Our main results provide evidence that in the US, the non-US banks contribute to the systemic risk although most of the contribution comes from the US banks. In the case of the UK we show that the banking industry contributes relatively more to systemic risk in periods of distress than the insurance industry or the other financial services industry. Furthermore, when we examine the estimated ΔCoVaR measures, we observe that for all sectors the contribution to systemic risk has increased since 2008.