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
New study: How does Europe become a leading player for software and IT services?
03.04.2017 | Fraunhofer-Institut für System- und Innovationsforschung (ISI)
Reusable carbon nanotubes could be the water filter of the future, says RIT study
30.03.2017 | Rochester Institute of Technology
More and more automobile companies are focusing on body parts made of carbon fiber reinforced plastics (CFRP). However, manufacturing and repair costs must be further reduced in order to make CFRP more economical in use. Together with the Volkswagen AG and five other partners in the project HolQueSt 3D, the Laser Zentrum Hannover e.V. (LZH) has developed laser processes for the automatic trimming, drilling and repair of three-dimensional components.
Automated manufacturing processes are the basis for ultimately establishing the series production of CFRP components. In the project HolQueSt 3D, the LZH has...
Reflecting the structure of composites found in nature and the ancient world, researchers at the University of Illinois at Urbana-Champaign have synthesized thin carbon nanotube (CNT) textiles that exhibit both high electrical conductivity and a level of toughness that is about fifty times higher than copper films, currently used in electronics.
"The structural robustness of thin metal films has significant importance for the reliable operation of smart skin and flexible electronics including...
The nearby, giant radio galaxy M87 hosts a supermassive black hole (BH) and is well-known for its bright jet dominating the spectrum over ten orders of magnitude in frequency. Due to its proximity, jet prominence, and the large black hole mass, M87 is the best laboratory for investigating the formation, acceleration, and collimation of relativistic jets. A research team led by Silke Britzen from the Max Planck Institute for Radio Astronomy in Bonn, Germany, has found strong indication for turbulent processes connecting the accretion disk and the jet of that galaxy providing insights into the longstanding problem of the origin of astrophysical jets.
Supermassive black holes form some of the most enigmatic phenomena in astrophysics. Their enormous energy output is supposed to be generated by the...
The probability to find a certain number of photons inside a laser pulse usually corresponds to a classical distribution of independent events, the so-called...
Microprocessors based on atomically thin materials hold the promise of the evolution of traditional processors as well as new applications in the field of flexible electronics. Now, a TU Wien research team led by Thomas Müller has made a breakthrough in this field as part of an ongoing research project.
Two-dimensional materials, or 2D materials for short, are extremely versatile, although – or often more precisely because – they are made up of just one or a...
28.04.2017 | Event News
20.04.2017 | Event News
18.04.2017 | Event News
28.04.2017 | Medical Engineering
28.04.2017 | Earth Sciences
28.04.2017 | Life Sciences