10:35 am - Wednesday June 28, 2017

Systemic risks and Investment Banking

 

In financial markets, the systemic risk is the risk of failure or collapse of the entire financial markets as opposed to the risk associated with any one of the asset classes, individual financial institution or group.

 

It can be attributed to the instability caused by characteristic events or conditions prevalent in the financial markets and or caused by various financial intermediaries.

 

It mainly arises out of the interlinks or interdependencies in the financial markets.

 

Thus the failure of one institution or group will have a cascading effect upon the whole financial markets.

 

Thus, systemic risk refers to the potential that an event, action or series of events or actions will have a widespread adverse effect on the financial system and, in consequence, on the economy.

 

Normally the following features contribute to the systemic risk

 

–          Size

–          Concentration

–          Interconnectedness

–          Structure

 

Size:

 

Size refers to the scale of activity (e.g. volumes) or positions (e.g. outstanding notional or mark to market amounts) in a defined institution or group or population. Financial institutions with large notional or mark to market amounts or volumes pose greater scope for systemic disruptions, than similar institutions with smaller notional or mark to market amounts and volumes when dealing in the same asset class.

 

Concentration:

 

Concentration refers to the relative role of individual financial institution or group of financial institutions within a market segment. The build-up of relatively large volumes of activity or relatively large positions (as measured by notional or mark to market amounts outstanding) in some defined institution, group or population could increase systemic risk

 

Interconnectedness:

 

Interconnectedness refers to the nature, scale and scope of obligations that arise between and among institutions. Analysis of interconnectedness involves describing and analysing the network of links across participants within segments of markets and or across different segments. It shows who the central players are, where the vulnerable links are and how the shape and characteristics of the network change over time. Analysis of the network complements the information on concentration and underpins the assessment of how far market participants are exposed to common shocks. Understanding interconnectedness is crucial for assessing the likelihood and extent of contagion in the financial system.

 

Structure:

 

A disruption in an area of the market that supports financial activity can be a significant source of systemic risk, both for financial institutions who rely on these markets for their funding and risk management activities and for other related financial markets.

 

Three dimensions namely depth, breadth and identity impact these four main systemic risk features – size, concentration, interconnectedness and structure.

 

Authorities with systemic risk mandates are concerned about systemic risk because it not only has the potential to harm a large number of investors and market participants, but because it also can have a widespread negative effect on financial markets and the economy.

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