MES vs ∆CoVaR: Empirical evidence from Pakistan

Hasan Hanif,Imran Yousaf,Waseem Ullah,Abdul Waheed,David Mcmillan

doi:10.1080/23311975.2021.1938927

Abstract

The global financial crisis unveiled that inadequate analysis of risk can annihilate the financial system and repercussions can encompass the whole economy. Pakistan is one of the developing economies that has experienced robust growth in the banking sector. This hard earned growth can only be sustained by adequately examining the risk exposure of the financial system. Consistent with this purview, this study attempts to comprehensively analyse for the first time, the systemic importance of financial institutions of Pakistan using ∆CoVaR and MES. Moreover, the study employs System GMM to analyze the bank, sector and country level determinants of systemic risk measures. The findings of the study signify that MES and ∆CoVaR measures identify different institutions as systemically important. Similarly, the influence of variables also changes with change in the systemic measure. The estimation of determinants of systemic risk outline that non-interst income is insignificant when MES is used as measure of systemic risk but the same turns significant for ∆CoVaR. The impact of deposit ratio also changes across the measures of systemic risk. Concentration has positive impact on MES but negatively influences ∆CoVaR. Finally, the impact of bank claims also varies across the measures of systemic risk. The study contributes to the literature by highlighting the complementary nature of systemic risk measures for the first time in a developing economy like Pakistan. The study also identifies important relationships necessary to chalk out micro and macro prudential regulations imperative for the stability of financial system.

Highlights

Financial institutions play a pivotal role in accelerating investment activities
Sys temically important banks should be scrutinized more than other banks and the changing impact of bank, sector and country level variables should be consistently observed by regulatory authorities
The analysis starts with computation of systemic risk measures followed by assignment of rank ings according to these measures

Summary

Introduction

Financial institutions play a pivotal role in accelerating investment activities. According to Levine (2005), financial intermediaries assist in accumulating capital and improve resource allocation that stimulate the whole economy. Regulations are introduced on the basis of the calculated systemic risk, so the diagnosis must be correct Consistent with this purview, many researchers have incorporated both contribution (∆CoVaR) and sensitivity (MES) measures simultaneously to comprehensively and adequately evaluate the systemic importance of banks. To the best of author’s knowledge this area remains untapped in a developing economy like Pakistan This study fills this gap by analyzing the systemic importance of banks in developing economy like Pakistan for the first time by simultaneously applying MES (Sensitivity) and ∆CoVaR (contribution) measures. The findings of the study call attention to the fact that complete systemic risk dynamics can only be understood if different facets of systemic risk are analyzed simultaneously. The study uses an extended data set comprising of nine firm level, three sector level and five country level variables spanning over 20 years

Literature review

Data and methodology

Results and interpretation

Conclusion