Predicting & Regulating the Systemic Risks of Financial Institutions

Abstract

This paper extends on the literature previously written exploring the health, soundness and vulnerabilities of the financial sector due to systemic risk. The aim of this study is to: (i) predict the risks of financial contagion and simultaneous bank failure; (ii) assess the liability of individual financial institutions to the financial system; and, (iii) evaluate the tools needed for effective management of systemic risk by central banks and regulators. To do this, I test the Systemic Expected Shortfall (SES) methodology on a portfolio of 29 of the largest U.S. financial institutions. This methodology illustrates the predicting capabilities of widespread market risk, contagion, and effects surrounding the global financial crisis. The analysis on the individual contribution of individual banks to the systemic risk of the financial system suggests that “Too-Big-to-Fail” is a legitimate trepidation from a macro-prudential perspective of bank regulation. In addition to testing the predictability and measurement of systemic risk, I will explore the complexities within the recent financial crisis that led to instances of heightened systemic risk. Furthermore, I evaluate the current themes in regulation, in order to assess the need for new predictive measures and macro-prudential regulatory reform.