## 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](https://www.imf.org/en/news/articles/2015/09/28/04/53/sores052314a)

## Other formats

- [Markdown version](/en/news/articles/2015/09/28/04/53/sores052314a/index.md)
- [Structured JSON version](/en/news/articles/2015/09/28/04/53/sores052314a/index.json)
- [Bundle manifest](/en/news/articles/2015/09/28/04/53/sores052314a/bundle-manifest.json)

## 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).*

---

## Content in this bundle

- [Indexpdf (PDF)](/-/media/websites/imf/imported/external/pubs/ft/irb/2014/01/_indexpdf.pdf){rel="external" type="application/pdf"}

---

## References

- [https://www.imf.org/en/News/country-focus](https://www.imf.org/en/News/country-focus)
- [PRESS CENTER](http://presscenter.imf.org/)
- [IMF Research](https://www.imf.org/en/news/search)
- [conference](http://www.imf.org/external/np/seminars/eng/2014/interconnect/index.htm)
- [See conference agenda](http://www.imf.org/external//np/seminars/eng/2014/interconnect/index.htm)
- [Global Financial Stability Report](http://www.imf.org/external/pubs/ft/gfsr/index.htm)
- [Research at the IMF](http://www.imf.org/external/research/index.aspx)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2015/09/28/04/53/sores052314a_