Systemic Import Analysis (SIA) – Application of Entropic Eigenvector Centrality (EEC) Criterion for a Priori Ranking of Financial Institutions in Terms of Regulatory-Supervisory Concern, with Demonstrations on Stylised Small Network Topologies and Connectivity Weights

Abstract

This paper presents a simple method for quantifying relative import amongst financial institutions in terms of the systemic risk they bear on any highly interconnected financial system to which they belong. W.r.t. the macroprudential framework comprising risk–based supervision and systemic–stability regulation, this paper distinguishes three levels of analysis based on network models of systemic phenomena, and appeals to the connectionist principle whereby an entity is deemed ‘systemically important’ if it materially impacts more of other ‘systemically important’ entities. This recursive definition essentially amounts to (Bonacich’s) Eigenvector Centrality (BEC) concept, yet BEC is not apt for macroprudential applications for a number of reasons. This paper thus proposes a weighted-network extension based on (information) entropy consideration, the Entropic Eigenvector Centrality (EEC) criterion, for assessing systemic implications of individual system entities, as per Systemic Import Analysis (SIA), and demonstrates its usage on a number of stylised small network topologies and connectivity weights, such as may represent channels of risk propagation amongst economic agents, esp. regulated and supervised financial institutions.