Abstract
Balance-sheet indicators may reflect, to a great extent, bank fragility. This inherent relationship is the object of theoretical models testing for balance-sheet vulnerabilities. In this sense, we aim to analyze whether systemic risk for a sample of US banks can be explained by a series of balance-sheet variables, considered as proxies for bank liquidity for the 2004:1–2019:1 period. We first compute Marginal Expected Shortfall values for the entities in our sample and then imbed them into a Random Forest regression setup. Although we discover that feature importance is rather bank-specific, we notice that cash and available-for-sale securities are the most relevant factors in explaining the dynamics of systemic risk. Our findings emphasize the need for heightened prudential regulation of bank liquidity, particularly in what concerns cash and immediate liquidity instrument weights. Moreover, systemic risk could be consistently tamed by consolidating bank emergency liquidity provision schemes.
Highlights
The recent global crisis that showed strong credit and liquidity issues motivated bank supervisors and regulators to reconsider the basics of banking regulations
Some studies expand on this issue and find strong evidence that balance-sheet data do hint towards systemic vulnerabilities (Bell and Hindmoor 2018), or that systemic risk is higher for banks with weak balance-sheet characteristics (Idier et al 2014)
Our investigation is motivated by the relevant role played by liquidity in systemic risk modeling for the case of the banking sector
Summary
The recent global crisis that showed strong credit and liquidity issues motivated bank supervisors and regulators to reconsider the basics of banking regulations. The general approach of considering the health of individual banks was appended with previsions of macro-prudential measures in a bid to deter potential systemic risk problems. There is a consensus about the fact that systemic risk generates negative externalities in the financial system that cannot be internalized by individual institutions. Negative shocks to bank capital are usually followed by asset selling and adjustments in lending. As capital shortages are rarely specific to one bank, such situations can amplify the impact of the original shock, so that systemic risk induces an overall scarcity of capital in the financial sector. As highlighted by Buch et al (2019) systemic risk expansion is catalyzed by the tendency of banks to be undercapitalized at moments when the entire financial system is undercapitalized, which further motivates the need for macro-prudential instruments
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