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Systemic Importance Index for financial institutions: A Principal Component Analysis approach

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  • Carlos Eduardo León
  • Andrés Murcia

Abstract

As a result of the most recent global financial crisis literature has embraced size, connectedness and substitutability as key indicators for financial institutions´ systemic importance. Despite the intuitiveness of these concepts, identifying systemic important institutions remain a non-trivial task that implies two primary challenges. First, designing metrics for connectedness and substitutability may require, as acknowledged by literature, non-standard data sources and techniques. Second, choosing a methodology capable of aggregating the metrics designed for the three aforementioned concepts into a systemic importance index may be intricate. The herein paper addresses the second challenge. The chosen approach is to apply Principal Components Analysis to the metrics designed by León and Machado (2011) for assessing size, connectedness and substitutability, where those metrics rely on a combination of balance sheet data and the application of network theory to large-value payment system´s information.Results (i) demonstrate that the three concepts and their metrics are explanatory and non-redundant for differentiating financial institutions´ relative systemic importance; (ii) allow for constructing a PCA-based Systemic Importance Index, a valuable tool for financial authorities´ policy and decision-making; and (iii) confirm the importance of the too-connected-to-fail criteria and the presence of non-banking firms among the most systemically important financial institutions in the Colombian case.

Suggested Citation

  • Carlos Eduardo León & Andrés Murcia, 2012. "Systemic Importance Index for financial institutions: A Principal Component Analysis approach," Borradores de Economia 10067, Banco de la Republica.
  • Handle: RePEc:col:000094:010067
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    Cited by:

    1. Carlos León & Clara Machado & Andrés Murcia, 2013. "Macro-prudential assessment of Colombian financial institutions’ systemic importance," Borradores de Economia 800, Banco de la Republica de Colombia.
    2. Wang, Hao & Xu, Ning & Yin, Haiyan & Ji, Hao, 2022. "The dynamic impact of monetary policy on financial stability in China after crises," Pacific-Basin Finance Journal, Elsevier, vol. 75(C).
    3. Carlos León & Clara Machado & Andrés Murcia, 2016. "Assessing Systemic Importance With a Fuzzy Logic Inference System," Intelligent Systems in Accounting, Finance and Management, John Wiley & Sons, Ltd., vol. 23(1-2), pages 121-153, January.
    4. Carlos León & Jhonatan Pérez, 2014. "Caracterización y comparación del mercado OTC de valores en Colombia," Revista de Economía Institucional, Universidad Externado de Colombia - Facultad de Economía, vol. 16(31), pages 223-250, July-Dece.
    5. Jacob Kleinow & Tobias Nell, 2015. "Determinants of systemically important banks: the case of Europe," Journal of Financial Economic Policy, Emerald Group Publishing Limited, vol. 7(4), pages 446-476, November.
    6. Rubio, Jeniffer & Pérez, Bryan & Arroyo, John, 2021. "Risk monitoring in Ecuador's payment system: Implementation of a network topology study," Latin American Journal of Central Banking (previously Monetaria), Elsevier, vol. 2(3).
    7. Jacob Kleinow & Andreas Horsch & Mario Garcia-Molina, 2017. "Factors driving systemic risk of banks in Latin America," Journal of Economics and Finance, Springer;Academy of Economics and Finance, vol. 41(2), pages 211-234, April.
    8. Martínez, Constanza & León, Carlos, 2016. "The cost of collateralized borrowing in the Colombian money market: Does connectedness matter?," Journal of Financial Stability, Elsevier, vol. 25(C), pages 193-205.
    9. Carlos León, 2012. "Implied probabilities of default from Colombian money market spreads: The Merton Model under equity market informational constraints," Borradores de Economia 743, Banco de la Republica de Colombia.
    10. Carlos León & Ron J. Berndsen, 2013. "Modular scale-free architecture of Colombian financial networks: Evidence and challenges with financial stability in view," Borradores de Economia 11104, Banco de la Republica.

    More about this item

    Keywords

    Systemic Importance; Systemic Risk; Principal Components Analysis; Too-connected-to-fail; Too-big-to-fail.;
    All these keywords.

    JEL classification:

    • D85 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Network Formation
    • C63 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Computational Techniques
    • E58 - Macroeconomics and Monetary Economics - - Monetary Policy, Central Banking, and the Supply of Money and Credit - - - Central Banks and Their Policies
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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