Bank Systemic Risk Research Articles

Tail systemic risk and contagion: Evidence from the Brazilian and Latin America banking network

In this study the tail systemic risk of the Brazilian banking system is examined, using the conditional quantile as the risk measure. Multivariate conditional dependence between Brazilian banks is modelled with a vine copula hierarchical structure. The results demonstrate that Brazilian financial systemic risk increased drastically during the global financial crisis period. Our empirical findings show that Bradesco and Itaú are the origin of the larger systemic shocks from the banking system to the financial system network, the real economy, and the region. The results have implications for the capital regulation of financial institutions and for risk managers' decisions.

Systemic Risk and Foreign Currency Positions of Banks: Evidence from Emerging Europe

This article investigates the impact of foreign currency (FX) denominated assets and liabilities on systemic risk by using a unique hand-collected dataset of bank-level FX positions for the period 2005–2012. The sample consists of banks from Central and Eastern Europe with large share of FX exposures on the balance sheet. Empirical findings indicate that systemic risk is dependent on the currency choice of financial institutions. While FX positions denominating in EUR and USD do not pose systemic risk concerns, FX positions denominating in exotic currencies like CHF significantly enhance the banks’ systemic importance. The negative influence of CHF positions might be reduced through prudent corporate governance mechanisms, tight restrictions on banking activity, and more restrictive limits on foreign currency lending in the home countries of the bank holding companies.

Dynamic Interaction Between Asset Prices and Bank Behavior: A Systemic Risk Perspective

We propose a simple model to simulate an interaction between banks and a financial market. In our model, banks are exposed to two sources of risks: market risk from their investments in assets external to the banking system and credit risk from lending in the interbank market. By and large, both risks increase during severe financial turmoil. In this scenario, the paper shows the conditions under which individual and the systemic defaults tend to coincide. This paper attempts to conduct a numerical simulation of banking ecosystems by using the actual values of financial items extracted from 89 Japanese banks’ balance sheets. From this numerical simulation, we confirm two points: (1) when financial market prices decrease due to crashes in a trend-followers-dominant market, banks lose their net worth coincidentally. Thus, the capital adequacy ratio decreases synchronously, and any bank may not provide other banks with money through the interbank markets. (2) In a contrarians-dominant or contrarians-predominant market, we observed mean-reverting fluctuations in market prices. Bankruptcies happen asynchronously, and market prices eventually decrease. However, other banks may provide the bank suffering from a shortage of assets with money through the interbank markets. We further compare the characteristics of the banking system in four types of market modes.

In search of a measure of banking sector distress: empirical study of CESEE banking sectors

We tested the reliability of different versions of the Z-score and CAMELS-based financial strength indices (aggregated from bank-level data) in detecting periods of banking crisis on a sample of 20 Central, Eastern, and Southeastern European (CESEE) countries during 1995–2014. We demonstrated that the predictive power of both types of accounting-based measures is weak. Our results cast some doubt on their usefulness in academic research and in the macroprudential monitoring framework for emerging economies. Thus, there is a need to strengthen the informational content of accounting data through more frequent and higher-quality data disclosures, including exposures allowing for analysis of interconnectedness and network effects for systemic banking risk monitoring.

Measuring the Systemic Risk of Regional Banks in Japan with PLS-SEM

I embark to measure the systemic risk of regional banks in Japan through shadow banking (microlevel and macrolevel linkages) using partial least squares structural equation modeling (PLS-SEM). Non-parametric PLS-SEM is used for the first time in the context of Japanese banks. I collect indicator-based data from Orbis Bank Focus but do not find all the indicators suggested by theory. Results indicate systemic risk is explained by 12.5% of shadow banking. I use generalized structured component analysis (GSCA) for robustness test because it belongs to the same family of methods as PLS-SEM; PLS-SEM results are confirmed by GSCA. Regulators need to collect more data regarding shadow banking activities in relation to regional banks in Japan. The missing indicators are critical for explaining systemic risk in regional banks through shadow banking. Once more data are available, researchers can explore whether shadow banking has a substantial effect on the systemic risk of regional banks in Japan.

Systemic Risk and Productivity of the Major Australian Banks

We measure the domestic systemic risk of the Australian major banks. We report systemic risk along five categories, namely, size, inter-connectedness, non-substitutability, complexity and domestic sentiment. We then carry out sensitivity analyses by changing equal weights in the categories, and examine the capital adequacy and inter-connectedness of the majors focusing on key ratios. In terms of sensitivity analyses, changing the equal weights do not influence systemic risk considerably, which indicates that the results are robust. Comparing systemic risk to productivity, we find that level systemic risk across time and high productivity are compatible, and rising systemic risk causes some inefficiency.

Comparing in- and out-of-sample approaches to variance decomposition-based estimates of network connectedness an application to the Italian banking system

We use methods that exploit variance decompositions from standard (rolling window) estimates of VAR(p) models to obtain estimates of network connectedness and perform an empirical comparison of the results derived under two alternative approaches: To base the decompositions on in-sample forecast errors vs. out-of-sample forecast errors derived from a separation between estimation and forecast evaluation window. Using the intraday realized variance of bank stock return, we derive novel empirical results on the systemic risk of the Italian banking system, whose network connectedness turns out to be generally high, increasing over time especially during the Great Financial and the European sovereign debt crises. However, whether a few net exporters of systemic risk may be reliably estimated turns out to depend on the methodology adopted when computing rolling window variance decompositions.

Corporate governance and systemic risk of Tunisian banks

This paper studies the relationship between systemic risk measures and internal governance mechanisms of banking institutions and managers' entrenchment level. Our study examines a sample of 11 Tunisian listed banks over the 2006 to 2013 period. The aim is to determine systemic banks, the main governance internal mechanisms and managers' entrenchment level that contributed to attenuating or amplifying individual and overall systemic risk. The empirical results indicate that the internal governance mechanisms of banking institutions are positively associated with the long run marginal expected shortfall (LRMES), and that the presence of a risk management committee has no effect on the level of systemic risk incurred by banks. However, the regression on the LRMES and the firm's percentage of financial sector shortfall reveals that the respect of the norms of governance of the banking institutions leads to the minimisation of the individual contribution of the banks to the overall systemic risk of the Tunisian banking sector.

Testing the Systemic Risk Differences in Banks

This paper contains a testing framework for the reliability of systemic risk measurement of banks, using the three leading market-based measures of systemic risk. We test whether the difference within the same category and across dfferent categories of systemic risk of individual banks is signifcant. We find that in general the systemic risk categories defined by the Financial Stability Board are dfferent from those constructed in a full pairwise comparison approach based on the market measures. Moreover, these dfferences were more pronounced during episodes of high market turbulence.To account for model risk we introduce a more robust ranking method based on nonparametric confidence intervals. We show that there is a large number of banks with overlapping confidence intervals of their market-based systemic risk measures.Further, similarity measures indicate that the scoring based rankings are not perfectly aligned with rankings produced by market based systemic risk measures.

Corporate governance and systemic risk of Tunisian banks

Corporate governance and systemic risk of Tunisian banks

Monitoring transmission of systemic risk: application of partial least squares structural equation modeling in financial stress testing

Regulators need a method that is versatile, is easy to use and can handle complex path models with latent (not directly observable) variables. In a first application of partial least squares structural equation modeling (PLS-SEM) in financial stress testing, we demonstrate how PLS-SEM can be used to explain the transmission of systemic risk. We model this transmission of systemic risk from shadow banking to the regulated banking sector (RBS) using a set of indicators (directly observable variables) that are sources of systemic risk in shadow banking and consequences of systemic risk measured in the RBS. Procedures for predictive model assessment using PLS-SEM are outlined in clear steps. Statistically significant results based on predictive modeling indicate that around 75% of the variation in systemic risk in the RBS can be explained by microlevel and macrolevel linkages that can be traced to shadow banking (we use partially simulated data). The finding that microlevel linkages have a greater impact on the contagion of systemic risk highlights the type of significant insight that can be generated through PLS-SEM. Regulators can use PLS-SEM to monitor the transmission of systemic risk, and the demonstrated skills can be transferred to any topic with latent constructs.

Bank Holdings and Systemic Risk

The recent financial crisis has focused attention on identifying and measuring systemic risk. In this paper, we propose a novel approach to estimate the portfolio composition of banks as function of daily interbank trades and stock returns. While banks? assets are reported to regulators and/or the public at relatively low frequencies (e.g. quarterly or annually), our approach estimates bank asset holdings at higher frequencies which allows us to derive precise estimates of (i) portfolio concentration within each bank?a measure of diversification?and (ii) common holdings across banks?a measure of market susceptibility to propagating shocks. We find evidence that systemic risk measures derived from our approach lead, in a forecasting sense, several commonly used systemic risk indicators.

Bank Regulation, Network Topology, and Systemic Risk: Evidence from the Great Depression

Bank Regulation, Network Topology, and Systemic Risk: Evidence from the Great Depression

Belgium: Financial System Stability Assessment-Technical Note- Stress Testing the Banking and Insurance Sectors and Systemic Risk Analysis

Belgium: Financial System Stability Assessment-Technical Note- Stress Testing the Banking and Insurance Sectors and Systemic Risk Analysis

Systemic risk and bank size

In this paper we analyse firm level systemic risk for US and European banks from 2004 to 2012. We observe that common systemic risk indicators are primarily driven by firm size which implies an overriding concern for “too-big-to-fail” institutions. However, smaller banks may still pose considerable systemic threats, as exemplified by the Northern Rock debacle in 2007. By introducing a simple standardisation, we obtain new risk measures that often prove to be superior predictors of financial distress during the 2007–2009 subprime crisis. We conclude that the new measures could be a valuable addition to the existing indicators employed in Basel III to identify systemically important banks.

Measuring the Systemic Risk of Regional Banks in Japan

I embark to measure the systemic risk of regional banks in Japan through shadow banking using PLS-SEM. Non-parametric PLS-SEM is used for the first time in the context of Japanese banks. I collect indicator-based data from Orbis Bank Focus but do not find all the indicators suggested by theory. Results indicate systemic risk is explained by 12.5% of shadow banking. Regulators need to collect more data regarding shadow banking activities in relation to regional banks. Once more data are available, researchers can explore whether shadow banking has a substantial effect on the systemic risk of regional banks in Japan.

Measuring Liquidity Mismatch in the Banking Sector

ABSTRACTThis paper constructs a liquidity mismatch index (LMI) to gauge the mismatch between the market liquidity of assets and the funding liquidity of liabilities, for 2,882 bank holding companies over 2002 to 2014. The aggregate LMI decreases from +$4 trillion precrisis to −$6 trillion in 2008. We conduct an LMI stress test revealing the fragility of the banking system in early 2007. Moreover, LMI predicts a bank's stock market crash probability and borrowing decisions from the government during the financial crisis. The LMI is therefore informative about both individual bank liquidity and the liquidity risk of the entire banking system.

Effects of Securitisation and Covered Bonds on Bank Stability

This paper empirically investigates the relationship of securitization and covered bonds with bank stability and highlights that this relation varies with the level of a bank's involvement in a specific instrument. The study uses the data from 46 securitizing and covered bond issuing listed banks in Europe for 2000-2014. The initial results show that some banks have been heavily involved in securitization activity, while covered bond issuance does not go beyond a certain limit. The results obtained using a quadratic model and a generalized additive model show a U-shaped relationship between securitization and systemic risk of the banks. However, this relationship is reversed for covered bonds. Small issuance of these bonds fails to provide the intended benefits and increases banks' risk. Further investigation reveals the presence of a strong size effect. The systemic risk of smaller banks increases after the issuance of covered bonds, while larger banks remain unaffected. The study does not support imposing uniform limits on covered bond issuance; instead such limits should be linked with the bank size. However, some regulatory framework is needed to limit banks' involvement in securitization.

Understanding the shift from micro- to macro-prudential thinking: a discursive network analysis

Macro-prudential thinking and its emphasis on endogenously created systemic risks, marginal in the banking regulation discourse until the mid-2000s, has become central post-crisis. This paper analyzes this intellectual shift by using discourse and citation-network analysis of the most-cited scholarly works on banking regulation and systemic risk from 1985 to 2014 and six in-depth interviews with central scholars. It demonstrates that the predominance of formalism, particularly partial equilibrium analysis, in studies on banking regulation pre-crisis impeded economists’ engagement with the endogenous sources of systemic risks discussed in the systemic risk sample. These studies excluded observed phenomena that could not be accommodated in mathematical models, largely ignoring contributions based on historical and practitioners’ styles of reasoning. Post-crisis, while informal analyses gain prominence in studies on banking regulation, attempts to conceptualize systemic risk as a negative externality indicate the persistence of formalism and equilibrium thinking and its concomitant epistemological limitations that stymie theoretical progress.

Systemic risk, bank’s capital buffer, and leverage

This paper measures individual bank’s impact on banking systemic risk and examines the effect of individual bank’s capital buffer and leverage to bank’s systemic risk impact in Indonesia during 2010-2014. Using Merton’s distance-to-default to measure systemic risk, the study shows a significant negative relationship between bank’s capital buffer and systemic risk. High capital buffer tends to lowering bank’s impact on systemic risk. Bank’s leverage level also influences its contribution to systemic risk, even though the impact is much lower compared to that of capital buffer impact.