Our grant financed by National Science Centre
Exogenous and endogenous determinants of systemic risk in the financial system
Grant NCN „Egzogeniczne i endogeniczne determinanty ryzyka systemowego w systemie finansowym” (UMO-2020/37/B/HS4/01893)
Keywords in Polish: Stabilność finansowa, ryzyko
systemowe, płynność, wypłacalność, COVID-19
Keywords in English: Financial stability, systemic
risk, liquidity, solvency, COVID-19
Start: February 5, 2021
Duration: 36 months
General abstract
The
onset of the global financial crisis brought about an increased concern about
systemic risk.
Systemic risk is the risk of widespread disruption of the financial system
implying a potential material damage to the economy (Bats & Houben, 2020). The
event of systemic risk could emerge from within the financial system when
the original shock is endogenously amplified by the fragilities and frictions
within the system such as excessive leverage, maturity mismatches or
interconnectedness (Danielsson et al., 2011). In this sense, the global
financial crisis in 2008 was a typical endogenous event as the crisis preyed on
the weaknesses of the financial system and misbehavior of market agents and
failure of regulatory institutions.
Alternatively, the trigger of the systemic event could be an exogenous shock,
which means from outside the financial sector. Unlike the 2008 crisis, the
current COVID-19 crisis, for example, did not originate in the banking sector
but it was rather caused by an unprecedent administrative lockdown of the
economies, which significantly affected demand and supply, public and private
sectors as well as financial markets. However, these two dimensions of risk are
not mutually exclusive and may materialize independently or in conjunction with
each other (ECB, 2009; 2019). In light of the most recent developments, the
spread of the coronavirus across the globe triggered abrupt and disorderly asset
price developments which led, in turn, to an acute increase in financial system
stress (IMF, 2020). The further systemic risk implications of the pandemic will
depend on how the vulnerabilities built up in recent years amplify the shock.
The paramount
distinctions between exogenous or endogenous triggers and sequential or
simultaneous impacts reveal the complexity of this phenomenon.
Against this background, the project explores different determinants of
systemic risk by distinguishing between an endogenous perspective of
systemic risk, where attention is confined to the financial system, and an
exogenous perspective of systemic risk in which the two-sided interdependence
between the financial system and the economy at large is considered. We
reduce the dimensionality problem resulting from the interaction of these
elements by limiting attention to two main forms of systemic risk: the risk
resulting from the interlinkages between different risks and intermediaries, and
the risk
of
widespread shock causing simultaneous problems across countries, sectors and/or
financial institutions.
Accordingly, we first focus on an endogenously self-reinforcing feedback loop
between liquidity, solvency and interconnectedness that can have serious
consequences for the stability of the financial sector.
Our main objective is to identify the
direction and evaluate the magnitude of the feedback effects between solvency
and liquidity risks, and their mutually reinforcing impact on systemic risk in a
banking sector.
We test the hypothesis that this channel is material as solvency and liquidity
are determined simultaneously and amplify each other, which results in an
increase of systemic risk. We also conjecture that financial vulnerabilities
such
as excessive leverage,
maturity mismatches or interconnectedness that
may play an important role in
the amplification of the initial shock effect.
Next,
we take a system-wide perspective in which systemic risk is triggered by the
exogenous shock that hits the world economy. We aim at investigating the role
of capital and liquidity buffers in mitigating the risk of negative feedback
loop and resulting contagion effect that affect the real economy and the
financial system as whole. We are going to compare and contrast the
coronavirus crisis with 2008 crisis, and in the process, gain some intelligence
on the role of certain banks’ features that determine whether banks can serve us
shocks absorbers or amplifiers of stress.
Basic literature
Acharya
V. V., Pedersen L. H., Philippon T., Richardson M. (2017),
Measuring Systemic Risk, The Review
of Financial Studies 30, Pages 2–47.
Adrian
T., Brunnermeier M. K., (2016), CoVaR,
American Economic Review, 106(7), pages 1705-1741, July.
Adrian, T.,
Boyarchenko, N., Giannone, D. (2019), Vulnerable growth, American
Economic Review, 109(4), 1263-89.
Bennett, R. L., Hwa, V., Kwast, M. L. (2015), Market discipline by bank
creditors during the 2008–2010 crisis, Journal
of Financial Stability, 20,
51-69.
Brownlees Ch., Engle R. F. (2017), SRISK:
A Conditional Capital Shortfall Measure of Systemic Risk, Review of
Financial Studies, Society for Financial Studies, vol. 30(1), pages 48-79.
Cai J.,
Eidam F., Saunders A., Steffen S. (2018),
Syndication, interconnectedness, and systemic risk, Journal of Financial
Stability, Elsevier, vol. 34(C), pp. 105-120.
Danielsson J, Macrae
R., Vayanos D., Zigrand J. (2020), The coronavirus crisis is no 2008,
VOX, 26 March 2020.
Espinosa-Vega M.,
Russell S. (2015), Interconnectedness, Systemic Crises and Recessions,
IMF Working Paper No. 15/46.
Holló D.
Kremer M., Lo Duca M., (2012), CISS - a composite indicator of systemic
stress in the financial system, Working Paper Series 1426, ECB.
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D. (2014), Systemic risk and the
solvency-liquidity nexus of banks, CORE Discussion Papers 2014038,
Université catholique de Louvain, Center for Operations Research and
Econometrics (CORE).
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M., Valderrama L. (2017), Bank Solvency
and Funding Cost: New Data and New Results, IMF Working Paper, WP/17/116.
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