Definition Of Systemic Risk Research Articles

Risk Assessment of Banks and Financial Institutions under COVID-19 Crisis

Systemic risk refers to risks that have a broad and severe impact on the entire financial system or economic system. There are similarities in the definition of systemic risk in China and abroad, which usually refer to threats to the entire financial system or economic system, which can trigger a chain reaction and lead to a systemic collapse. In terms of characteristics and measurements, there may be some differences in views and methods at home and abroad. While foreign countries usually pay more attention to the interconnectedness of financial institutions, market liquidity, macroeconomic factors, etc., China may pay more attention to factors such as the stability of financial markets and the role of state-owned enterprises and governments in the economy. The shortcomings of systemic risk abroad may lie in the fact that the unique circumstances of some characteristic countries or regions are sometimes overlooked, because these factors are not universally applicable on a global scale. Due to its unique environment of large economic size, complex financial system, government intervention, and the influence of state-owned enterprises, the study of systemic risk is particularly important for China. This particular situation may require unique methods and metrics to measure and address risks to ensure the stability and sustainability of China's financial system. It is precisely in view of the lack of foreign research on China's specific context that it is of great significance to study the systemic risk of China's banking industry under China's financial system.

Systemic risk measures and regulatory challenges

This paper discusses different definitions of systemic risk and identifies the challenges, which regulators face in addressing this phenomenon. We conducted a systematic literature review of 4859 abstracts to categorize the various methodologies developed to measure systemic risk. In total, 60 systemic risk measures proposed post-2000 have been critically appraised to inform academics and regulators of their practical applications and model vulnerabilities. This review suggests that most of these methods focus on individual financial institutions rather than on system stability. Those methodologies directly reflect the current regulations, which aim to ensure individual institutions’ soundness. As macro-prudential regulation evolves, policy-makers face the issues of understanding contagion and how regulations should be implemented. This paper also discusses new systemic risk and regulatory challenges resulting from the current COVID-19 pandemic.

A Review of Micro-Based Systemic Risk Research from Multiple Perspectives.

The Covid-19 pandemic has brought about a heavy impact on the world economy, which arouses growing concerns about potential systemic risk, taking place in countries and regions. At this critical moment, it makes sense to interpret the systemic risk from the perspective of the financial crisis framework. By combing the latest research on systemic risks, we may arrive at some precautions relating to the current events. This literature review verifies the origin of systemic risk research. By comparing the retrieved and screened systemic literature with the relevant research on the financial crisis, more focus on the micro-foundations of systemic risk has been discovered. Besides, the measurement methods of systemic risks and the introduction of interdisciplinary methods have made the research in this field particularly active. This paper synthesizes the previous research conclusions to find the appropriate definition of systemic risk and combs the research literature of systemic risk from two lines: Firstly, conducting the division according to the sub-branch fields within the financial discipline and the relevant interdisciplinary research methods, which is helpful for scholars within and outside the discipline to have a more systematic understanding of the research in this field. Secondly predicting the research direction that can be expanded in this field.

On the Origin of Systemic Risk

Systemic risk in the banking sector is usually associated with long periods of economic downturns and very large social costs. On one hand, shocks coming from correlated exposures towards the real economy may induce correlation in banks’ default probabilities thereby increasing the likelihood for systemic-tail events like the 2008 Great Financial Crisis. On the other hand, financial contagion also play an important role in generating large-scale market failures, amplifying the initial shocks coming from the real economy. To study the sources of these rare phenomena, we propose a new definition of systemic risk (i.e. the probability to have a large number of banks going into distress simultaneously) and thus we develop a multilayer microstructural model to study empirically the determinants of systemic risk. The model is then calibrated on the most comprehensive granular dataset for the euro area banking sector, capturing roughly 96% or EUR 23.2 trillion of euro area banks’ total assets over the period 2014-2018. The outputs of the model decompose and quantify the sources of systemic risk showing that correlated economic shocks, financial contagion mechanisms, and their interaction are the main sources of systemic events. The results obtained with the simulation engine nicely resemble common market-based systemic risk indicators and empirically corroborate findings from the existing literature. This framework represents to regulators and central bankers a tool to study systemic risk and its developments, pointing out that systemic events and banks’ idiosyncratic defaults have different drivers, hence implying different policy responses.

Systemic Risk in the Insurance Industry and Its Impact on the Economy

Systemic risk, defined as the risk that a failure of a large financial institution could lead to counterparty failures and could trigger adverse effects for the real economy, has been a priority for both academicians and policy-makers. The literature focuses on the measures and definition of systemic risk and on its impact on the financial sector with little or no attention given to the relationship between systemic risk and the real economy. In this paper, we investigate the link between the systemic risk in the insurance sector and the macro economy during the 2008 financial crisis. In particular, we test the predictive power of insurance companies’ systemic risk of macroeconomic downturns using various measures of systemic risk constructed from daily returns for 169 insurance companies between 1988 and 2011. Our findings show that insurance systemic risk forecasts macroeconomic downturns three months into the future.

Systemic Risk and the Dynamics of Financial Networks

This paper has two main objectives: first, to provide a formal definition of endogenous systemic risk that is firmly grounded in equilibrium dynamics of financial networks; and second, to construct a discounted stochastic game (DSG) model of the emergence of equilibrium network dynamics that fully takes into account the feedback between network structure, strategic behavior, and risk. Based on our definition of systemic risk we also propose a formal definition of tipping points. Using these tools we then provide a strategic approach to making global assessments of systemic risk in financial networks. Our approach is based on three key facts: (1) the equilibrium dynamics which emerge from the game of network formation generate finitely many disjoint basins of attraction as well as finitely many ergodic measures (implying that, starting from any financial network, in finite time with probability one, the dynamic sequence of financial networks arrives at one of these basins and once there stays there), (2) each basin of attraction is homogenous with respect to its default characteristics (meaning that if a basin contains states having a particular set of defaulted players, then all states contained in this basin have the same set of defaulted players), and (3) the unique profile of basins generated by the equilibrium dynamics carries with it a unique set of tipping points (special states) - and these tipping points provide an early warning of network failure.

Supernetworks and Systemic Risk

We give a formal and computable definition of systemic risk that is firmly grounded in network dynamics and using our definition we show that the dynamics driving network formation generate a finite set of basins of attraction. The presence of basins of attraction has major implications for our understanding of systemic risk. First, we show that each basin is homogeneous with respect to its network failure characteristics. Second, we show that the profile of basins comes equipped with a unique set of tipping points. Thus, using our definition of systemic risk, we formally define the notion of a tipping point. Each tipping point is the gateway to some sequence of future networks leading inexorably to some basin, and depending on the failure characteristics of this basin, this sequence might best be described as a failure cascade. Thus, tipping points are the supernetwork’s early warning system for network failure. Finally, we define and characterize the notions of systemic and killer nodes. The big picture take away from our approach to systemic risk is that what is critical in assessing systemic risk is the allocation of failure levels across the basins of attraction.

Monitoring Systemic Risk A Survey of the Available Macroprudential Toolkit

Understanding the nature of systemic risk and identifying the channels of diffusion of the shocks are the necessary prerequisite to anticipate and manage successfully the insurgence of financial crises. In order to prevent financial distress and manage instability, the macroprudential regulator needs to track and measure systemic risks ex-ante. The aim of the paper is twofold: on one side, it reviews the theoretical frameworks which allow to assess the different dimensions of systemic risk and, on the other, it classifies accordingly and analyzes the methodologies available to assess in advance the occurrence of systemic distress. The paper classifies the different definitions of systemic risk and discusses their significance during the 2007-08 crisis. It presents the tools available to extract real time information on market perception of risk from market prices of securities and derivatives (i.e. CDS and equity options). The analysis is extended to the methods focused on the measurement of the financial fragility due to the networks linkages within the financial system. On the basis of the available empirical research, the paper also reviews the capacity of the different methods to spot in advance the insurgence of the crisis prior to 2007-08 and draws some preliminary conclusions on the completeness and consistency of the toolkit available to policy makers.

Systemic Importance of Financial Institutions: Regulations, Research, Open Issues, Proposals

In the field of risk management, scholars began to bring together the quantitative methodologies with the banking management issues about 30 years ago, with a special focus on market, credit and operational risks. After the systemic eff ects of banks defaults during the recent fi nancial crisis, and despite a huge amount of literature in the last years concerning the systemic risk, no standard methodologies have been set up to now. Even the new Basel 3 regulation has adopted a heuristic indicator-based approach, quite far from an e ffective quantitative tool. In this paper, we refer to the di fferent pieces of the puzzle: defi nition of systemic risk, a set of coherent and useful measures, the computability of these measures, the data set structure. In this challenging fi eld, we aim to build a comprehensive picture of the state of the art, to illustrate the open issues, and to outline some paths for a more successful future research. This work appropriately integrates other useful surveys and it is directed to both academic researchers and practitioners.

Systemic operational risk: does it exist and, if so, how do we regulate it?

Since the global financial crisis, banking regulators and academics have extended the traditional, narrow definition of to encompass concepts such as interconnectedness and shadow banking. But, at the time of writing, a definition of systemic risk that covers all of the factors that precipitated the global financial crisis is still emerging. This paper first describes the debate around the emerging definition(s) of systemic risk and discusses some of the initiatives to address systemic risk by international regulators. These initiatives include microprudential regulations, such as increasing capital for systemically important banks, and macroprudential initiatives, such as the creation of the European Systemic Risk Board. Recognizing that systemic risks arise not only from credit and market risk factors, this paper views systemic risk through the lens of operational risk, arguing that key risk factors, especially people and process risks, were pervasive across the global financial industry prior to the global financial crisis and, consequently, operational risk must be considered as a contributor to, and in some instances a trigger for, systemic risk. The paper goes on to describe the microprudential approach to operational risk within the Basel II regulations and identifies and describes operational risks that were present prior to the global financial crisis. The paper concludes that there is indeed a systemic dimension to operational risk that should be recognized and addressed by banking regulators.Finally, the paper makes some suggestions as to how the management of systemic operational risks may be addressed by banks and regulators.

A Network Model for Bank Lending Capacity

We provide a structural framework to study the impact of a macroeconomic shock on the banking sector’s lending capacity. Our model consists of three building blocks: first, the evolution of non-bank assets that provide the entrance point for shocks from the real economy into the banking sector. Second, a network model that describes the propagation of the shock. Third, regulatory capital constraints that restrict banks’ lending behaviour. Therefore, the framework combines the literature on systemic risk and the literature on the bank lending channel. The building blocks ensure that our model captures six important aspects: firstly, by measuring systemic risk as the reduction in lending capacity, it aligns the model definition of systemic risk to the definition of the European Systemic Risk Board. Secondly, it models banks’ lending behavior as a function of counterparty risk addressing the usual critique of missing microfoundations of bank behavior. Thirdly, it emphasizes that not only defaulted banks, but also distressed banks are a thread for the real economy due to reduced lending capacity. Fourthly, our model shows the procyclicality of current (static) capital requirements. Fifthly, it allows us to study the effects of micro-prudential capital requirements in a network setting. And finally, the model describes the feedback loop of a shock that stems from the real economy through the banking sector back into the real economy.

Insurers as Systemically Important Financial Institutions (SIFIs)? Exploration and Methodology

This paper focuses on developing a methodology for identifying potential Systemically Important Financial Institutions (SIFIs) in the insurance sector. While many contend that insurers do not cause systemic risk, regulators asked to include insurers in the SIFI designation. In order to operationalise the identification process for potential SIFIs, the methodology suggested in this paper uses the definitions of the Financial Stability Board (FSB) and the International Association of Insurance Supervisors (IAIS) for systemic risk. The categories are: 1. Size, 2. Interconnectedness, 3. Substitutability, and 4. Timing, in combination. With these categories in mind, we adopt the results of the seminal report of the Geneva Association “Systemic Risk in Insurance” (2010) which regards the activities of insurers as the key for the analysis. The report concludes that core or traditional insurance activities do not fit into the definition of systemic risk. Activities that are quasi banking or non-core thus may fit into potentially systemically risky activities (pSRAs). Thus, the first step of our proposed methodology is a discovery of pSRAs in insurance. PSRAs are not indicators to insolvency. They are used in the second phase for a discovery of those insurers that engage in pSRAs. Briefly, Phase I is the methodology to discover pSRAs, and Phase II is the methodology to find which insurers are engaged in pSRAs and determine whether they meet SIFI status. Only such insurers are to be scrutinized for a potential designation as SIFIs. Such insurers’ engagement in pSRAs will be measured and examined based on benchmarks indicators in Phase II. If their exposure to the pSRA is above the indicators’ benchmarks, those insurers will be a “pSRA insurer.” Further studies are expected since the IAIS is calling for data collection. The engagement in a pSRA over a specified benchmark should not lead automatically to a SIFI designation of an insurer. As long as the insurer can carry the activity, it should not cause a systemic problem to the economy. Therefore, the current regulatory system is engaged to additional measures of such a “pSRA insurer.” Key is the institutional engagement in pSRAs. The pSRAs is the added dimension above the solvency regulation system. Examples of pSRAs we use here are: derivatives for speculations and mismanagement of short term investments. Indicators in Phase II are provided as well.

Market Dynamics & Systemic Risk

This paper presents a possible solution to financial crises by addressing the core of the problem of systemic risk. To get there, it first illustrates a number of crises related situations before the definition of systemic risk is detailed. It then explains challenges of systemic risk and solutions on an institutional level before the consequences for micro- and macro- prudential regulation for the global financial system are set out.As the definition of systemic risk presented is applicable to other areas, not only finance or economics, but any kind of system, as long as parts, relationships and interactions are clearly identifiable or definable, it can be seen as relevant to manage risk in the hemispheres of long-range health, unpredictable environment, complex high-tech/energy/resource competition, and even (international) politics of a society/world at large.The systemic risk definition provided – the first operationalizable – takes a self-critical view with failure-reducing tendencies to be on the safe side if/when the results of our actions are unknown. It also operates the verbal level to avoid the aversion of policy makers regarding limited data-sets, over-simplified village-fair economies and limited model-proving/unrealistic assumptions.It takes a value-based approach to ensure longevity and accounts for (non)rationality to ensure robustness in the face of (un)realized complexity, chaos, and intrinsicality/intangibility as far as possible even indirectly addressing the unknown unknowns.

A network model of systemic risk: stress testing the banking system1

Although there are many definitions of systemic risk, most agree that it manifests itself by an initial shock that results in the failure of one or more banks and then spreads out to the entire sys...

A network model of systemic risk: stress testing the banking system1

AbstractAlthough there are many definitions of systemic risk, most agree that it manifests itself by an initial shock that results in the failure of one or more banks and then spreads out to the entire system by a contagion mechanism which can result in the failure of more banks in the system. Assuming that bank failures in the initial shock are randomly dependent on the failure probabilities of the individual banks and that the ensuing contagion process is deterministic, depending on interbank exposures, in this paper we propose a network model to analyse systemic risk in the banking system that, in contrast to other proposed models, seeks to obtain the probability distribution of losses for the financial system resulting from the shock/contagion process.Thus, calculating the probabilities of joint failures by simulation and assuming that the matrix of bilateral interbank exposures is known, we represent systemic risk in the financial system by means of a graph and use discrete modelling techniques to characterize the dynamics of contagion and corresponding losses within the network. The probability distribution of losses, risk profile for the Mexican banking system, is obtained through an efficient, complete enumeration procedure of all possible bank default events in the system. This, in turn, allows the use of the wide variety of well‐established risk measures to describe the fragility of the financial system. Additionally, the model allows us to perform stress tests along both the bank default probabilities and the interbank exposures and is used to assess the risk of the Mexican banking system. Copyright © 2009 John Wiley & Sons, Ltd.

Banking Regulation and Systemic Risk

The term Systemic Risk belongs to the standard rhetoric of economic policy discussions related to the banking industry. Besides the goal of protecting small depositors, control of systemic risk is given as one of the main arguments for banking regulation. Various recent financial crises have increasingly focused the regulatory debate on issues of systemic risk and financial stability. There is, however, no generally accepted definition of systemic risk and the effectiveness and the economic consequences of various instruments of banking regulation that are intended to attenuate it are still only partially understood both theoretically and empirically. In this paper, we make an attempt to discuss some of the issues raised in this debate by reviewing recent contributions to the academic literature.