Perspective on Systemic Risk Measurement

Institutions, markets and payments infrastructures are the main constituents of a financial system. Among Financial Institutions (FIs), banks occupy center stage. It is never enough to emphasize their importance as financial intermediaries transforming liquidity. They play a pivotal role in allocating resources efficiently. Therefore, soundness of banks, as individual entities, as well as a collection – industry – is of utmost importance in any debate on financial and macroeconomic stability. However, among many lessons learnt from recent financial crises (2007-09) it can be underlined that FIs work as a complex web and risks and vulnerabilities present in one part have the potential to damage rest of the financial system.

In fact, apart from banks, non-bank financial institutions like insurance companies, investment houses, hedge funds, mutual funds, money-market funds, fund-of-funds, venture capitals, mortgage houses, and brokers/dealers are of great importance to understand interdependence of FIs within a system. In addition, non-financial firms also play their part and add to the complexity of this web even further. Therefore, any risk management strategy or model focusing on a particular activity or single institution would not be able to cover the risks posed to the whole industry, irrespective of the fact that risk originated from macroeconomic factors or snowballed by domino effect or contagion. Thus, need for a system-wide model is immediate and undeniable.