IMF Survey : Financial Networks Key to Understanding Systemic Risk
IMF News, May 28, 2014
Source details
- Canonical URL
- IMF Survey : Financial Networks Key to Understanding Systemic Risk
Other formats
Bibliographic details
- Authors: Camelia Minoiu, Sanjay Sharma May
- Published: May 28, 2014
Network perspective and motivation
- Financial markets are highly interconnected; analyzing “networks” in the financial system helps deepen understanding of systemic risk and is key to preventing future financial crises.
- Financial transactions create a “financial network”; understanding how these networks function and how robust they are is critical to establishing rules to manage systemic risk.
- The global financial crisis highlighted contagion and systemic risk driven by interconnectedness of economic agents.
Conference overview (Interconnectedness: Building Bridges between Research and Policy)
- Publication date: May 28, 2014.
- Conference held on May 8-9, 2014; jointly organized by the IMF’s Research Department and the Monetary and Capital Markets Department in collaboration with the Institute for New Economic Thinking and the Deutsche Bundesbank.
- Key questions addressed:
- Why are some financial networks more stable than others?
- What is the link between the structure of a network and contagion?
- What are the advantages of a high degree of interconnectedness for individual institutions?
- Is there a trade-off between network resilience to shocks and social welfare?
Major findings from speakers and panels
- Joseph Stiglitz (keynote)
- Before the 2007–2008 crisis, diversification/interconnectedness was viewed positively; the crisis showed that high interconnectedness “facilitated the breakdown” and became “part of the problem.”
- There is no single optimal financial architecture; systemic risk depends on the interplay of architecture with capital buffers, asset market liquidity, correlations, and the nature of shocks.
- “An architecture that might work well under one circumstance might not work well in another.”
- A network that evolves on its own should not be presumed socially efficient.
- Banks can be “too interconnected, too central, and too correlated to fail” in addition to being too big to fail—creating moral hazard concerns.
- Interconnectedness spans linkages within the financial sector and between the financial sector and the real economy; bankruptcies can have real costs, as in the 1997–98 East Asian crisis.
- Policy prescription: limit interconnectedness and foster “a richer diversity of financial institutions” to reduce too-correlated-to-fail structures and improve resilience.
- Claudia Buch (Deutsche Bundesbank)
- Indirect financial linkages (common exposures and business models) matter significantly.
- Empirical research is insufficiently guided by theory; pragmatic use of existing datasets with a common methodology is recommended.
- Sujit Kapadia (Bank of England)
- Future research should focus on real world network structures and core institutions at the center of networks.
- Important indirect channels include liquidity risk (banks withdrawing funding from each other), fire sales, and fear-driven contagion linked to uncertainty.
- Focusing on counterparty risk and defaults alone is insufficient because contagion and externalities often occur before default.
- Nellie Liang (Federal Reserve Board)
- Systemic risk can generate real economy costs before defaults occur and is often procyclical.
- Key research areas include:
- Whether interconnectedness can generate systemic risk without excessive leverage or maturity transformation.
- How to expand network analyses of the federal funds market to the multi-trillion dollar derivatives markets.
- How much information about individual institutions should be disclosed after stress tests.
- How to identify non-bank systemically important financial institutions (SIFI).
- Policy question: “How do we incorporate interconnectedness into stress tests?”
- Patricia Mosser (Office of Financial Research)
- Research should focus on wholesale funding markets.
- Global SIFIs will take time before they can report counterparty risk data comparably across institutions.
- Creating data platforms and using “innovative technology solutions” to safeguard and analyze data is important.
- Sanjay Sharma (RBC Capital Markets)
- Reporting lags (e.g., financial statements) and opaque disclosure documents (e.g., a 500-page disclosure) complicate assessing current risk.
- Crisis-era data may be of limited use for predicting the next crisis due to unprecedented government interventions.
- Proposed practical solution: implement a universal global codification framework (a barcode system for every financial transaction) to better understand financial flows and exposures.
Methodological and research directions
- Static networks are a useful starting point, but research should incorporate time-varying risk in networks (risk that varies over the business cycle).
- Empirical work needs stronger links to theory; many panelists called for research on procyclicality of networks and leading vulnerabilities in the financial system.
- Important to consider indirect channels of contagion and behaviors occurring prior to defaults.
Data gaps and policy-relevant recommendations
- Major obstacle: data gaps, especially on nonbanks, shadow banks, and linkages with the non-core financial system.
- Specific data challenges: netting, treatment of derivatives, balance sheet items that mask underlying exposures, and comparability of counterparty risk reporting across global SIFIs.
- Recommendations:
- Use existing country datasets with a common methodology as a pragmatic first step.
- Build data platforms and employ innovative technology to safeguard and analyze data.
- Explore a universal global codification framework (barcode system) for financial transactions as a cost-effective solution to the “data black hole problem.”
Source: IMF Survey : Financial Networks Key to Understanding Systemic Risk, May 28, 2014 (IMF Research conference summary).