Measuring systemic risk: A risk management approach |
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Institution: | 1. Columbia Business School, Columbia University, United States;2. Department of Economics, University of Oxford, United Kingdom;3. Institute for New Economic Thinking, Oxford Martin School, United Kingdom;4. Office of Financial Research, U.S. Treasury, United States;1. Reserve Bank of Australia, Sydney, Australia;2. Bank of England, London, United Kingdom;3. Institute of Global Finance, University of New South Wales, Sydney, Australia;1. Bank of Canada, 234 Wellington Street West, Ottawa, ON K1A 0G9, Canada;2. International Monetary Fund, 700 19th St NW, Washington, DC 20431, United States;1. LEO, University of Orléans, France;2. Maastricht University, The Netherlands;3. EconomiX, University of Paris West Nanterre la Défense, France;1. Chaire d’information financière et organisationnelle (UQAM), Laboratory for Research in Statistics and Probability, Université du Québec (Outaouais), 101 St. Jean Bosco, Gatineau, Québec J8X 3X7, Canada;2. Université du Québec (Montréal), École des sciences de la gestion, 315 Ste. Catherine est, R-3555, Montréal, Québec H2X 3X2, Canada;3. Chaire d’information financière et organisationnelle (UQAM), Université du Québec (Outaouais), Canada |
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Abstract: | This paper proposes a new method to measure and monitor the risk in a banking system. Standard tools that regulators require banks to use for their internal risk management are applied at the level of the banking system to measure the risk of a regulator’s portfolio. Using a sample of international banks from 1988 until 2002, I estimate the dynamics and correlations between bank asset portfolios. To obtain measures for the risk of a regulator’s portfolio, I model the individual liabilities that the regulator has to each bank as contingent claims on the bank’s assets. The portfolio aspect of the regulator’s liability is explicitly considered and the methodology allows a comparison of sub-samples from different countries. Correlations, bank asset volatility, and bank capitalization increase for North American and somewhat for European banks, while Japanese banks face deteriorating capital levels. In the sample period, the North American banking system gains stability while the Japanese banking sector becomes more fragile. The expected future liability of the regulator varies substantially over time and is especially high during the Asian crisis starting in 1997. Further analysis shows that the Japanese banks contribute most to the volatility of the regulator’s liability at that time. Larger and more profitable banks have lower systemic risk and additional equity capital reduces systemic risk only for banks that are constrained by regulatory capital requirements. |
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