Systemic Risk, an Empirical Approach

We have developed a quantitative analysis to verify the extent to which the sources of systemic risk identified in the academic and regulatory literature actually contribute to it. This analysis shows that all institutions contribute to systemic risk albeit to a different degree depending on various risk factors such as size, interconnection, un-substitutability, balance sheet and risk quality. From the analysis we conclude that using a single variable or a limited series of variables as a proxy for systemic risk generates considerable errors when identifying and measuring the systemic risk of each institution. When designing systemic risk mitigation measures, all contributing factors should be taken into account. Likewise, classifying institutions as systemic/non-systemic would mean giving similar treatment to institutions that may bear very different degrees of systemic risk, while treating differently institutions that may have very similar charge of systemic risk inside. Therefore, we advocate that some continuous approach to systemic risk -in which all institutions are deemed systemic but to varying degrees- would be preferable. We acknowledge that this analysis may prove somehow limited in the way that it is not founded on a predefined conceptual approach, does not fully consider other very relevant qualitative factors1 and accounts only for some of the relevant sources of systemic risk in the banking system2. These limits are currently set due to data availability and state of the art in empirical research, but we believe that these should not hinder our work identifying the true sources of systemic risk and our aim to help avoiding any partial and thus limited prudential policy approach.