Measuring systemic importance of financial institutions: An extreme value theory approach

Abstract

In this paper, we define a financial institution's contribution to financial systemic risk as the increase in financial systemic risk conditional on the crash of the financial institution. The higher the contribution is, the more systemically important is the institution for the system. Based on relevant but different measurements of systemic risk, we propose a set of market-based measures on the systemic importance of financial institutions, each designed to capture certain aspects of systemic risk. Multivariate extreme value theory approach is used to estimate these measures. Using six big Canadian banks as the proxy for Canadian banking sector, we apply these measures to identify systemically important banks in Canadian banking sector and major risk contributors from international financial institutions to Canadian banking sector. The empirical evidence reveals that (i) the top three banks, RBC Financial Group, TD Bank Financial Group, and Scotiabank are more systemically important than other banks, although with different order from different measures, while we also find that the size of a financial institution should not be considered as a proxy of systemic importance; (ii) compared to the European and Asian banks, the crashes of U.S. banks, on average, are the most damaging to the Canadian banking sector, while the risk contribution to the Canadian banking sector from Asian banks is quite lower than that from banks in U.S. and euro area; (iii) the risk contribution to the Canadian banking sector exhibits " home bias ", that is, cross-country risk contribution tends to be smaller than domestic risk contribution. JEL classification: C14, C58, G21, G32 Bank classification: Financial stability; Financial system regulation and policies; Financial institutions; Econometric and statistical methods RésuméLes auteurs définissent la contribution d'une institution financière au risque systémique financier comme la hausse que connaîtrait ce risque si l'institution s'effondrait. Plus l'établissement en question contribue au risque systémique, plus il revêt de l'importance du point de vue du système. En se basant sur différentes mesures pertinentes de ce risque, les auteurs proposent un assortiment d'indicateurs de marché de l'importance systémique des institutions financières, dont chacun rend compte d'aspects distincts du risque systémique et qui sont construits à partir de techniques multivariées inspirées de la théorie des valeurs extrêmes. Armés de ces indicateurs, ils repèrent les institutions d'importance systémique dans le secteur bancaire canadien (ramené aux six principales banques du pays) ainsi que les institutions financières étrangères qui contribuent de façon significative au niveau de risque à l'échelle du secteur. Trois grandes conclusions ressortent de leurs estimations. D'abord, les trois plus grosses banques -RBC Groupe financier, le Groupe Financier Banque TD et la Banque Scotia -ont un poids systémique plus élevé, mais leur classement par ordre d'importance varie selon l'indicateur utilisé;...

Measuring systemic risk across financial market infrastructures

“…Extreme value methods have proved to be an e¤ective way to calculate probabilities of tail events in the …nancial system (Gravelle and Li, 2013). To the best of our knowledge, these methods have not been used to estimate systemic risk in the network of FMIs.…”

“…Authors such as Lehar (2005), Segoviano et al (2009), Gravelle and Li (2013), and Adrian and Brunnermeier (2015), among others, have proposed measures of the systemic importance of a …nancial institution or group of …nancial insti- 1 The three FMIs have been designated as "systemically important" by the Payment Clearing and Settlement Act because they have the potential to pose systemic risk to Canada's …nancial system. tutions in the …nancial system.…”

“…theory methods, pioneered by Fisher and Tippett (1928) to measure the systemic importance of …nancial institutions. See Poon et al (2004), Hartmann et al (2005), Acharya et al (2010) or Gravelle and Li (2013), to cite a few. These methods have been proven to be useful for measuring tail events in the …nancial industry.…”

Using Weighted Shapley Values to Measure the Systemic Risk of Interconnected Banks

“…The literature has recently proposed and used a number of alternative measures. Huang et al (2010), Acharya et al (2010), Gravelle and Li (2013) and Drehmann and Tarashev (2013) compute the systemwide loss distribution, define a set of systemic events and equate the systemic importance of a particular bank with the expected losses that it generates in these events.…”

“…First, we draw inspiration from related literature (e.g. Acharya et al, 2010;Huang et al, 2010;Drehmann and Tarashev, 2013;Gravelle and Li, 2013) to select a sympathetic characteristic function. We focus on the expected losses that each subsystem imposes on its creditors when banks in the subsystem suffer an insolvency problem.…”