Systemic Risk

The following sections are included:

• Dedication
• Acknowledgements
• Contents
• List of Figures
• List of Tables
• About the Authors
• Introduction

Systemic risk and systemic crises have a long history, reaching (at least) as far back as the Tulip Mania in the 17^th century. This part presents cases of systemic bank crises, their trigger events, and their impact. We aim at understanding the different aspects of systemic risk and systemic crises…

This chapter presents a short overview of the international history of systemic risk in the 1980s and 1990s. To highlight its facets, we select particular systemic crises that occurred during those years. To show the international dimension of systemic risk, we look at systemic risk in both developing and developed countries. Our crises cover (all) different geographical regions (North America, Latin America, Europe, Asia, Australia, Middle East/Africa) and different mechanisms through which systemic risk manifests itself…

Technological and financial innovation, as well as the globalization of business, have had a huge impact on banks. From the late 1990s onward, the interconnectedness of banks and the competition within the banking sector have significantly increased on a global level; see, e.g., Kroszner (2000). Different from the crises in the 20^th century, systemic crises in the 21^st century have no longer been confined to individual countries but have a strong international, even a global, dimension…

The previous chapters presented several systemic crises over the last five decades. We have identified several characteristics of systemic risk. This chapter will provide a short review of the common features in systemic crises.

This part discusses measurement of systemic risk. As we have seen in Part 1, systemic risk has many facets through which it affects not only the financial system, but also economic activities in general. Measuring risk of the entire financial system is of particular interest to financial regulators and, as such, is a good starting point to assess the impact of systemic events…

In Chapters 1–3, we have shown that systemic events have common features across time and how a globalized financial system in the new century has created new challenges. Accordingly, the definition of what constitutes systemic risk has evolved over time. This chapter presents an overview of systemic risk and its evolution…

We start our discussion of systemic risk measures with broad economic concepts that influence this form of risk. This prepares the ground for systemic risk measurement in Section 5.2. Finally, Section 5.3 provides an overview of measures based on market data…

Classical measures to assess market risk are Value-at-Risk (VaR) and Expected Shortfall (ES). In addition, factor models have been very popular to assess the credit risk of banks; see Crosbie and Bohn (2002) and Saunders and Cornett (2009)…

This chapter studies the temporal evolution of systemic risk from 2000 to 2016. We use a dataset consisting of 578 banks and covering the geographical regions of the world that we looked at in Chapter 1…

This part discusses prudential regulation and the institutional framework for effective supervision of systemic risk.

Prudential regulation of a financial system faces a series of challenges. As in other industries, regulation in the financial landscape needs to be justified by noting a market failure and determining that public intervention would improve welfare. However, once a market failure has been identified and regulation is deemed necessary, peculiar characteristics of financial markets and financial institutions pose additional challenges to policy-making. We start with Chapter 8 by enumerating these challenges, their potential implications, and solutions…

In the wake of the GFC of 2008–2009, the terms systemic risk and macro-prudential regulation came to the forefront. Traditional banking regulation had largely disregarded systemic risk by focusing on individual institutions. This lack of a macro-prudential perspective, which is essential to preserve financial stability, constituted the main shortcoming of prudential regulation before the crisis. The traditional, micro-prudential regulation framework also failed by allowing banks to operate at very low levels of capital and to avoid controls through regulatory arbitrage and through soft supervision of key risks…

Prudential regulation of a financial system needs to take complementary perspectives to mitigate as many risks as possible. A micro-prudential view focuses on individual institutions and markets. This approach assumes that, if financial institutions are safe and sound individually, then the financial system will be stable. The accords of Basel I and II represent examples of this view applied to banking regulation. Unfortunately, the global financial crisis makes it clear that this approach has limited capacity to control market failures leading to systemic risk. Point in time characteristics of financial systems (e.g., the size and interconnectedness of financial institutions) and dynamic considerations (e.g., procyclicality) generally shape the micro-prudential approach and justify a macro-prudential perspective. We will study these perspectives in Sections 9.1 and 9.2…

The implementation of prudential regulation and the execution of resolution policies face important institutional challenges. Basically, it implies a delegation of power to specific regulatory authorities. Delegation opens a series of principal-agent problems because the interests of a regulator (an agent) may not coincide with those of society (the principal). Hence, a clear specification of the agency’s mandates and tools, as well as correctly designed governance and accountability arrangements, are necessary to align incentives. The optimal design of the contract between society and regulators matters because it determines responsibilities, powers, constraints, and compensations. Also important is the architecture and institutional design of the safety net because it specifies the ways in which synergy among agencies must be exploited, as well as how checks and balances must operate…

The following section is included:

• Bibliography