Systemically Important Banks Research Articles

Measuring Network Systemic Risk Contributions: A Leave-One-Out Approach

Granger-causality measures of interconnectedness between financial institutions are useful indicators of systemic risk (Billio et al., 2012) [Journal of Financial Economics], as they help in evaluating how far the distress of one institution is disseminated across the whole of the financial system through networks. This article provides a critical assessment of Granger-causality networks, showing that they can lead to inconsistent measures of systemic risk contributions because of the presence of spurious causalities arising from indirect contagion effects. The traditional solutions for controlling for these effects using inference on conditional Granger-causality lead to the curse of dimensionality though. To solve this, we provide a measure of financial network systemic risk contributions that is based on the leave-one-out (LOO) concept. For a given financial institution, the new measure evaluates how far the total number of significant Granger-causalities breaks down when this institution is excluded from the system. We control for spurious causalities between the remaining institutions due to the indirect contagion effect of the excluded financial institution using a conditional Granger-causality test, which is free of the curse of dimensionality. Empirical applications are conducted using daily market returns for a sample of the world’s largest banks. The results show that our measure gives a meaningful ranking of the systemic importance of financial institutions that is consistent with the ranking of global systemically important banks (G-SIBs) provided by the Financial Stability Board (FSB). Moreover, our measure is shown to be a robust and significant early-warning indicator of large losses from a systemic event, and is strongly driven by balance-sheet variables related to size, business model and profitability.

Adding Fuel to the Fire Sales: Banks, Capital Regulation, and Systemic Risk

In a model with heterogeneous banks and endogenous fire sales, the tightening of bank capital regulation can aggravate fire sales, leading to larger bank losses and higher systemic risk. When calibrated to the data, the least costly policies to mitigate systemic risk raise both ex ante capital requirements and ex post shortfall penalties. These policies also assign relatively higher capital requirements to banks that can better offset price declines during a fire sale, consistent with the recently implemented capital surcharge for global systemically important banks (G-SIBs). My findings provide further support for leading-edge macroprudential tools, including stress tests and countercyclical capital buffers.

The Rising Systemic Importance of Chinese Banks: Should the World Be Concerned?

AbstractInternational regulators use data on systemic importance for additional capital requirements for banks with cross‐jurisdictional operations. Chinese banks’ importance scores have risen significantly and China stands as the world's largest net creditor. Furthermore, commercial banks in China have recorded higher non‐performing loans ratios across 2013–2015. Tracking systemic risk is a core activity in enabling macroprudential regulation. We focus on Chinese commercial banks and rank them as domestic systemically important banks (D‐SIBs). We then identify those high ranking D‐SIBs that are also global systemically important banks (G‐SIBs). We investigate whether high ranking D‐SIB/G‐SIB banks have adequate capital and their interconnectedness.

Bank rescues and bailout expectations: The erosion of market discipline during the financial crisis

We design a novel test for changes in market discipline based on the relation between firm-specific risk, credit spreads, and equity returns. We use our method to analyze the evolution of bailout expectations during the recent financial crisis. We find that bailout expectations peaked in reaction to government interventions following the failure of Lehman Brothers, and returned to pre-crisis levels following the initiation of the Dodd-Frank Act. We do not find such changes in market discipline for nonfinancial firms. Finally, market discipline is weaker for government-sponsored enterprises (GSEs) and systemically important banks (SIBs) than for investment banks.

Financial networks and interconnectedness in an advanced emerging market economy

Financial networks could become fragile during periods of economic and financial distress, since interconnectedness among participating firms could transmit and amplify adverse shocks. Relying on balance sheet data, complemented with information on interbank exposures, this paper analyses interconnectedness in an advanced emerging market economy, using two complementary approaches. The first approach focuses on the financial network topology, and finds that the financial system resembles a highly clustered small world network, with in and out-degrees, connectivity and exposures exhibiting a (double) heavy tail behaviour, which favours the formation of strong community structure and preferential attachment in the network. Bank size is Pareto distributed, and highly correlated with centrality. The second approach focuses on how the network topology contributes to the transmission of shocks by modelling default contagion, using balance sheet network analysis. It finds that direct counterparty credit exposure poses less risk to the banking system than fire sale losses triggered by liquidity shocks. Both approaches, either using a topological or induced system losses perspective, identify systemically important financial institutions (SIFIs) consistently by accounting for both macro and microprudential risk dimensions.

Reprint of: Stopping contagion with bailouts: Micro-evidence from Pennsylvania bank networks during the panic of 1884

Using a newly constructed historical dataset on the Pennsylvania state banking system, detailing the amounts of “due-froms” on a debtor bank-by-debtor bank basis, we investigate the effects of the Panic of 1884 and subsequent private sector-orchestrated bailout of systemically important banks (SIBs) on the broader banking sector. We find evidence that Pennsylvania banks with larger direct interbank exposures to New York City changed the composition of their asset holdings, shifting from loans to more liquid assets and reducing their New York City correspondent deposits in the near-term. Over the long-term though, only the lower correspondent deposits effect persisted. Our findings show that the banking turmoil in New York City impacted more exposed interior banks, but that bailouts of SIBs by the New York Clearing House likely short-circuited a full-scale banking panic.

Behavioral risks at the systemic level

The possibility of Deutsche Bank being fined some US$14 billion by US regulators for grave misconduct before the global financial crisis (GFC) has recently raised the specter of a systemic banking crisis, as Deutsche Bank is considered to be a systemically important bank (SIB). Since the GFC, Deutsche Bank and several other SIBs have been made to pay over US$200 billion in fines and remediation costs for misconduct in a number of areas, beyond misselling of mortgages, such as manipulation of the London interbank offered rate (Libor) and foreign exchange (FX) benchmarks; misselling of insurance products (such as payment protection insurance); sanctions busting; money laundering; and other misconduct. This paper points out that these events are the result of a failure to manage operational risks, both at the level of the firm and across the banking system. Although research into individual and group behavioral biases has increased, less research has been conducted into misbehavior at the level of the banking system, that is, misconduct which occurs in multiple financial institutions, seemingly independently, at the same time. By comparing the Libor and FX benchmark manipulation scandals, this paper describes how misbehavior emerged independently in both of these markets and the conditions that permitted the misconduct to survive and thrive. This paper also identifies areas for further research in the field.

Ending Too-Big-To-Fail: Progress Since the Crisis, the Importance of Loss-Absorbing Capacity and the UK Approach to Resolution

In 2008 the largest cross-border banks were too big to fail and had to be bailed out, inappropriately penalising taxpayers and rewarding bank investors. This paper reviews the major progress since then in seeking to end ‘too-big-to-fail’. This has involved several strands: the development of resolution regimes; the negotiation and agreement of cooperative resolution strategies for global systemically-important banks (G-SIBs); the identification of barriers to resolvability; and paving the way to removing those barriers. A crucial aspect of this is requiring all banks to have sufficient loss-absorbing capacity to ensure their orderly resolution. Following adoption by the G20 of the Financial Stability Board’s standard on total loss-absorbing capacity (TLAC), the UK authorities have recently published their policy on TLAC and its Bank Recovery and Resolution Directive equivalent Minimum Requirement for Own Funds and Eligible Liabilities (MREL)—the minimum requirement for own funds and eligible liabilities. The provisions link both the quantum and quality of TLAC or MREL resources to the preferred resolution strategy, whether that is bail-in, partial transfer or liquidation, on a case-by-case basis. This ensures that a one-size-fits-all approach is not taken to resolution of different types of bank. The UK rules also provide a degree of flexibility to UK banks in meeting their MRELs, both by specifying appropriate transitional arrangements and by making the final requirements subject to review by the UK authorities. This will take into account any changes to the UK regulatory environment in coming years and the actual experience of UK banks in raising loss-absorbing resources.

Market Reactions to the Single Resolution Mechanism - Credibility of New Bail-In Regulation

This paper provides evidence on how announcements about the new European regulation on bank resolution impacted credit default swaps and equity values of banks. Using an event study methodology, abnormally high CDS spreads are observed during the provisional SRM agreement on 20 March 2014, the date when the legislative authority agreed to the rules and the financing of the resolution fund was clarified. This suggests that investors perceive that the probability that banks will be bailed out is significantly lowered by the new bail-in rules. A multivariate analysis detects that reactions are stronger for global systemically important banks (G-SIBs) than for other banks, suggesting that they enjoyed a higher implicit guarantee ex-ante than non-G-SIBs. Other bank-specific explanations for reacting are tested but found to be less significant.

Europe's CoCos Provide a Lesson on Uncertainty

Contingent convertible bonds (CoCos) issued by European global systemically important banks (GSIBs) as part of their total loss-absorbing capacity (TLAC) are meant to enhance financial stability by forcing investors to absorb losses when a bank is under stress. Coupon payments are made at issuers’ discretion while loss absorption can be triggered at regulators’ discretion. This study investigates price effects of four press releases by Deutsche Bank AG in February 2016 related to the bank’s willingness and ability to make its upcoming CoCo coupon payments. Expected cash flow models capture changes in CoCo default risk, while event dates capture uncertainty effects. The price of a European G-SIB peer group portfolio declined a statistically significant 2.0-2.5 percent over two days in response to Deutsche Bank’s first press release. Deutsche Bank’s efforts to allay its own CoCo investors’ concerns appeared to increase concerns among CoCo investors generally. The results show potential negative effects of regulatory discretion.

How to Define a Systemically Important Financial Institution (SIFI) A New Perspective

The recent financial crisis has demonstrated that a failure of Systemically Important Financial Institutions (SIFIs) could seriously damage the stability of the financial system. A precise and consistent definition of a SIFI is pivotal to ensure efficient and effective regulation of the global financial sector. This paper proposes a threefold test logic that allows to classify Financial Institutions as systemically important across the various industry segments.

Contagion Risk in Global Banking Sector

Abstract This paper investigates contagion risk for the global banking environment using three different distance to risk measures (distance to default, distance to capital, and distance to insolvency). The timeframe for this research covers a period that is characterized by substantial financial innovation in regards to regulatory, monetary and technological change experienced in the banking environment. Our hypothesis is that volatility in the banking structure of a particular country upsurges the prospect of financial volatility in another. We model extreme shocks for banks by replicating four separate conditions of financial stress. We compute the probability of these states moving from one country′s banking system to another by employing multinomial logistic model. In total, we investigate the possibility of extreme event in one country′s banking system as a function of extreme events in other countries banking systems throughout our sample period. Our sample consists of ninety-one banks from twenty countries including all G8 and BRICS countries in operation from 6th January 2006 up to 31st December 2015. Overall, we find evidence of strong correlations between countries’ banking systems especially between those of UK and US. Our findings suggest the need for greater regulatory control over banks operating as global systemically important banks (GSIBs).

What happened to global banking after the crisis?

PurposeLarge global banks were at the heart of the global financial crisis. In response to the crisis, the Financial Stability Board published an integrated set of policy measures, such as capital surcharges, to address the systemic and moral hazard risks associated with global systemically important banks (G-SIBs). Almost 10 years later, it is time to take stock of the impact of these measures. This paper answers three questions on what happened to the G-SIBs. First, have they shrunk in size? Second, are they better capitalised? Third, have they reduced their global reach?Design/methodology/approachThis paper looks at the individual G-SIBs and compares the situation before the crisis with the current situation. In this methodology, the differences because of changes at individual banks and changes in the ranking within the group (composition effect) are disentangled. Data have been collected on these banks from SNL Financial (banking database) and annual reports.FindingsFirst, a substantial increase in capital levels is seen, though the distribution is uneven. China and USA are leading the pact with leverage ratios (Tier 1 capital divided by total assets) of around 7 per cent for their large banks, whereas Europe and Japan are trailing behind with ratios between 4 and 5 per cent. Second, a strong composition effect is identified: a shift of business from the global European banks to the more domestic Asian banks, which are gradually increasing their global reach. The US banks keep their strong position. So, the decline in cross-border banking is largely because of a composition effect (i.e. a reshuffle of the global banking champions league) and far less due to a reduced global reach of individual banks.Research limitations/implicationsFrom the results on capital, recommendations are made on capital requirements (see below at social implications).Social implicationsIt is noted that the euro area, Japan, Sweden and Switzerland trail behind with a leverage ratio between 4 and 5 per cent. It is recommended these countries bring the leverage ratio of their largest banks more in line with international practice.Originality/valueThe effects of the reform after the global financial crisis on the large global banks have not been researched in detail. This paper split the results by country of incorporation (home country). This gives interesting differences, which the paper relates to specific policies (or lack of policies) in these countries.

How to Define a Systemically Important Financial Institution — A New Perspective

The recent financial crisis has demonstrated that a failure of systemically important financial institutions (SIFIs) could seriously damage the stability of the financial system. A precise and consistent definition of a SIFI is pivotal to ensure efficient and effective regulation of the global financial sector. This paper proposes a threefold test that indicates which financial institutions are systemically important across the various industry segments.

Contagion risk for Australian banks from global systemically important banks: Evidence from extreme events

This paper presents evidence that extreme negative shocks for the global systemically important banks (GSIBs) are contagious to Australian banks. Our logit regression models predict transmission of adverse extreme shocks in the distance to default (DD) of GSIBs to the Australian banks. While most previous studies consider contagion across national stock markets, we investigate the degree of contagion risk for Australian banks spreading from GSIBs. Our results point to the critical importance for the Australian Prudential Regulation Authority (APRA) (2015) to closely observe and monitor developments across the major GSIBs and direct appropriate local policy measures accordingly.

Banks’ asset and liability valuation in the new regulatory environment: a game theory perspective

In the aftermath of the global financial crisis, US regulators have required banks to disclose more details regarding the valuation techniques of their traded assets and liabilities. Using data from 2013 to 2014 annual reports for nine primary dealers, we examine the determinants of the choice of the valuation techniques in a game theory setup. Consistent with their publicly disclosed shareholder policy, we assume that the banks’ objective is to maximize their return on equity. Our key findings are threefold. First, we show that the optimal strategy for the global systemically important banks (G-SIBs) is to select the valuation techniques associated with a lower level of risk. Conversely, the optimal strategy for the non-G-SIBs is to select the valuation techniques associated with a higher level of risk. Finally, we demonstrate that the above optimal strategies are consistent over time. These findings are in line with the regulators’ mindset to reduce the balance sheet riskiness of G-SIBs.

Systemic Risk Measurement: Bucketing G-SIBs Between Literature and Supervisory View

The general consensus on the need to enhance the resilience of the financial system has led to the imposition of higher capital requirements for certain institutions, supposedly based on their contribution to systemic risk. Global Systemically Important Banks (G-SIBs) are divided into buckets based on their required additional capital buffers ranging from 1% to 3.5%. We measure the marginal contribution to systemic risk of 26 G-SIBs using the Distressed Insurance Premium methodology proposed by Huang et al. (2009) and examine ranking consistency with that using the SRISK of Acharya et al. (2012). We then compare bucketing using the two academic approaches and supervisory buckets. Because it leads to capital surcharges, bucketing should be consistent, irrespective of methodology. Instead, discrepancies in the allocation between buckets emerge and this suggests the complementary use of other methodologies.

Are Basel's Capital Surcharges for Global Systemically Important Banks Too Small?

The Basel Committee promulgates bank regulatory standards that many major economies enact to a significant extent. One element of the Basel III capital standards is a system of capital surcharges for global systemically important banks (G-SIBs). If the purpose of the surcharges is to ensure the survival of G-SIBs through serious crises (like the 2007-09 financial crisis) without extraordinary public assistance, our analysis suggests that current surcharges are too low because of three shortcomings: (1) the Basel system underestimates the probability that a G-SIB can fail, (2) the Basel system fails to account for short-term funding, and (3) the Basel system excludes too many banks from current surcharges. Our best estimate suggests that the current surcharges should be between 225 and 525 basis points higher for G-SIBs that are not reliant on short-term funding; G-SIBs that are reliant on short-term funding should have even higher surcharges. Furthermore, we find that, even with significant confidence in the effectiveness of other Basel III reforms, modest increases in surcharges appear needed.

Are Basel's Capital Surcharges for Global Systemically Important Banks Too Small?

The Basel Committee on Banking Supervision (BCBS, the Basel Committee, or Basel) has developed a methodology for identifying global systemically important banks (G-SIBs) and standards for requiring G-SIBs to hold more common equity.

In Search of Financial Stability in Nigeria: From Legislation to Effective Regulation of Banks

The systemic importance of banks in any economy brings to the fore the inevitability of exploring ways of keeping banks not only strong but also within the safety level desired by depositors and financial managers. This is underscored by the invaluable and fundamental roles of these financial institutions in the maintenance of financial stability. The state of banking regulation in Nigeria, especially before the introduction of reforms in the sector, had given serious cause for concern. This observation is in light of serious illiquidity and systemic distress that was synonymous with the banking sector in Nigeria in the 1990s and even into the opening years of the twenty-first century. This article examines in detail the legal and institutional frameworks for banking regulation in Nigeria. It finds that the challenge of ineffective regulation of the banks in the country may not necessarily be associated with the dearth or non-comprehensiveness of statutes on the subject but rather borders on uncoordinated and ineffective enforcement mechanisms, coupled with policy inconsistency on the part of banking regulators. This situation engenders confusion, uncertainty and instability because prospective investors tend to be more hesitant, depositors shy away from saving with banks and banks tend to have to grapple with persistent illiquidity when the system is unpredictable. The article therefore advocates a policy shift from legislative review to effective enforcement of the existing laws regulating banks in Nigeria in order to grow these financial institutions into transparent, efficient, strong and globally competitive institutions.