Systemic Risk Definition
Abstract
The advent of the recent financial crisis has signalled the importance of having a total picture of the overall financial system instead of earlier focus by academicians and policy makers on individual banks. This new approach is termed as the Macro-prudential perspective and tries to understand the interconnectedness of financial institutions as well the effect of pro-cyclicality (the tendency for problems to be hidden during boom and exposed during crisis) to the financial system and the overall economy. Such totalitarian approach needs an effective system to identify those financial institutions with the capacity to distract the operations of financial markets or with the ability to breakdown the entire financial system. This paper
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Systemic risk is a vague subject who does not have generally accepted definition. Hansen (2012) points out that the definitions of systemic risk ranges from simple credit shortage triggered by liquidity concerns of a bank, to a other complex susceptibility of a financial system to an explained shocks, or a bankruptcy of a major institution in the financial system. IMF (2009) definition of systemic risk focuses on impairments of a parcel or the entire financial system, which have potential to expose the system to the risk of disruption to financial services, which could hamper the functioning of the economy. The G-10 Report on Financial Sector Consolidation (2001) define systemic risk to be a negative occurrence with potential to destroy the confidence displayed in financial systems, and leading to a greater risk of disturbing the economy. On the other hand, IMF (2009) defines systemic importance of financial institution as if an exit or being under critical situation of a firm have the potential to create and lead to a system-wide contagion directly by counterparty transactions or indirectly through fire sale or other means, then the firm is …show more content…
Their study covers period from 1986 to 2010, of market data on daily market equity data, which they obtain from CRSP. They find that a higher volatility, repo spread and lower market return to be the main indicators of a financial crisis, and any organization involved in an environment full of these market variable to be considered as SIFI. In their study they compared the VaR of each institution against the CoVaR which implies when the institution fails, and conclude that they are very different and authorities need to focus on the VaR of the companies which doesn’t reflect the spill over effect, rather they need to focus and measure the CoVaR. By associating their CoVaR measure with balance sheet data, they claim they were able to predict the occurrence of the financial crisis in 2007. Using the combination of balance sheet data and their SIFI identification methodology, they find that organizations having higher leverage (more debt), more maturity mismatch and that are big in size, to contribute a lot to the systemic
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