Decomposition of Systemic Risk Drivers in Evolving Financial Networks

In this paper, we propose a methodology to decompose drivers of systemic risk that arise due to insolvency contagion in evolving financial networks. There is an ongoing discussion on how network topology and capital buffer influence systemic risk. On the one hand, the network contagion literature tends to emphasize the influence of the network topology. On the other hand, policy works tend to discuss restrictions over the capital buffers of financial institutions. Systemic risk is usually a complex function of both risk drivers and thus isolating the contributive effects of each risk driver to systemic risk is not a trivial task. Our decomposition methodology identifies and isolates these effects. We apply our methodology to the global banking network and find that the network topology effect explains most of the systemic risk measure's volatility. Additionally, we show that the capital buffer effect explains the persistent reduction in systemic risk buildup with effects concentrated around the global financial crisis. Our results confirm the importance of both risk drivers to measuring systemic risk.