Banks can significantly improve the effectiveness of their stress-testing exercises by incorporating systemic risk measures.
Systemic Risk Monitor 1.0: A Network Approach
Tony Hughes, Managing Director and Samuel Malone, Director
In this paper, we introduce a new risk management tool focused on network connectivity between financial institutions. Our methodology cuts to the heart of the problem of systemic risk measurement and assessment. Our toolkit, which we call the Systemic Risk Monitor (SRM), will be indispensable for regulators seeking to fulfill their mandates to avoid banking crises.
What is Systemic Risk?
Systemic risk refers to a shock that results in a broad-based failure of the financial system, which in turn threatens to jeopardize the economy. The initial shock(s) can be exogenous (an oil price shock, for example) or endogenous (the bankruptcy of a systemically important firm).