The risk of a financial crisis is substantially higher than previously estimated, according to new research that accounts for multiple levels of interconnectedness in the financial system.
The study, published in the journal Financial Stability, introduces a new method that allows researchers to estimate the systemic risk that emerge from multiple layers of connectivity.
“Systemic risk is the risk that a significant part of the financial system stops working—that it cannot perform its function,” says IIASA Advanced Systems Analysis program researcher Sebastian Poledna, who led the study. For example if a major bank fails, it could trigger the failure of other financial institutions that are linked to it through loans, derivatives, securities, and foreign exchange exposure. The fear of such contagion is what drives governments to bail out banks.
“Previous studies of systemic risk had just examined one layer of this system, the interbank loans,” says Poledna. The new study expands this to include three other layers of connectivity: derivatives, securities, and foreign exchange. By including the other layers, Poledna and colleagues found that the actual risk was 90% higher than the risk just from interbank loans.
Currently, financial regulators tend to use market-based measures to estimate systemic risk. The researchers find that these measures also underestimate the actual risk. In Mexico, which the researchers used as a case study, they found that systemic risk levels are about four times higher today than before the financial crisis—yet these risks are not reflected in market-based measures.
“Banks today are far more connected than they were before the financial crisis,” explains Poledna. “This means that in a new crisis, the public costs for Mexico could be four times higher than those experienced in the last crisis,”
The new method would make it possible to create systemic risk profiles for markets and individual institutions, which could prove useful for financial regulators aiming to prevent future crises.
In addition, the methodology provides a way to estimate the cost and repercussions of a bank failure, which could help financial policymakers determine whether a bailout would be worth the cost. Bank bailouts come at a huge cost to taxpayers, yet until now, there has been no clear method of determining the cost to the system of not bailing out a failing bank.
Poledna points out that the new method may still underestimate systemic risk, as it leaves out two additional potential sources of risk – overlapping investment portfolios, and funding liquidity. The researchers are now working in collaboration with the IIASA Risk, Policy and Vulnerability program on a new study that brings in these additional layers.
The study relied on data from the Mexican banking system but the researchers say that the method could be used for any country, as long as the data were available.
Poledna A. Molina-Borboa JL, Martinez-Jaramillo S, van der Leij M, Thurner S (2015). The multi-layer network nature of systemic risk and its implications for the costs of financial crises. Financial Stability.
For more information contact:
Risk Policy and Vulnerability
Advanced Systems Analysis
+43(0) 2236 807 261
Senior Research Scholar
Advanced Systems Analysis
+43(0) 2236 807 380
MSc Katherine Leitzell | idw - Informationsdienst Wissenschaft
Win-win strategies for climate and food security
02.10.2017 | International Institute for Applied Systems Analysis (IIASA)
The personality factor: How to foster the sharing of research data
06.09.2017 | ZBW – Leibniz-Informationszentrum Wirtschaft
University of Maryland researchers contribute to historic detection of gravitational waves and light created by event
On August 17, 2017, at 12:41:04 UTC, scientists made the first direct observation of a merger between two neutron stars--the dense, collapsed cores that remain...
Seven new papers describe the first-ever detection of light from a gravitational wave source. The event, caused by two neutron stars colliding and merging together, was dubbed GW170817 because it sent ripples through space-time that reached Earth on 2017 August 17. Around the world, hundreds of excited astronomers mobilized quickly and were able to observe the event using numerous telescopes, providing a wealth of new data.
Previous detections of gravitational waves have all involved the merger of two black holes, a feat that won the 2017 Nobel Prize in Physics earlier this month....
Material defects in end products can quickly result in failures in many areas of industry, and have a massive impact on the safe use of their products. This is why, in the field of quality assurance, intelligent, nondestructive sensor systems play a key role. They allow testing components and parts in a rapid and cost-efficient manner without destroying the actual product or changing its surface. Experts from the Fraunhofer IZFP in Saarbrücken will be presenting two exhibits at the Blechexpo in Stuttgart from 7–10 November 2017 that allow fast, reliable, and automated characterization of materials and detection of defects (Hall 5, Booth 5306).
When quality testing uses time-consuming destructive test methods, it can result in enormous costs due to damaging or destroying the products. And given that...
Using a new cooling technique MPQ scientists succeed at observing collisions in a dense beam of cold and slow dipolar molecules.
How do chemical reactions proceed at extremely low temperatures? The answer requires the investigation of molecular samples that are cold, dense, and slow at...
Scientists from the Max Planck Institute of Quantum Optics, using high precision laser spectroscopy of atomic hydrogen, confirm the surprisingly small value of the proton radius determined from muonic hydrogen.
It was one of the breakthroughs of the year 2010: Laser spectroscopy of muonic hydrogen resulted in a value for the proton charge radius that was significantly...
17.10.2017 | Event News
10.10.2017 | Event News
10.10.2017 | Event News
20.10.2017 | Information Technology
20.10.2017 | Materials Sciences
20.10.2017 | Interdisciplinary Research