An accessible and detailed overview of the risks posed by financial institutions Understanding Systemic Risk in Global Financial Markets offers an accessible yet detailed overview of the risks to financial stability posed by financial institutions designated as systemically important. The types of firms covered are primarily systemically important banks, non-banks, and financial market utilities such as central counterparties. Written by Aron Gottesman and Michael Leibrock, experts on the topic of systemic risk, this vital resource puts the spotlight on coherency, practitioner relevance, conceptual explanations, and practical exposition.
Step by step, the authors explore the specific regulations enacted before and after the credit crisis of 2007-2009 to promote financial stability. The text also examines the criteria used by financial regulators to designate firms as systemically important. The quantitative and qualitative methods to measure the ongoing risks posed by systemically important financial institutions are surveyed.
- A review of the regulations that identify systemically important financial institutions
- The tools to use to detect early warning indications of default
- A review of historical systemic events their common causes
- Techniques to measure interconnectedness
- Approaches for ranking the order the institutions which pose the greatest degree of default risk to the industry
Understanding Systemic Risk in Global Financial Markets offers a must-have guide to the fundamentals of systemic risk and the key critical policies that work to reduce systemic risk and promoting financial stability.
Table of Contents:
Preface xiii
Acknowledgments xvii
About the Authors xviii
Chapter 1 Introduction to Systemic Risk 1
What Is Systemic Risk? 2
Systemic Risk Drivers 3
Why Systemic Risk Must Be Understood, Monitored, and Managed 5
Chapter 2 How We Got Here: A History of Financial Crises 9
Common Drivers of Historical Crises 10
Bursting of Asset Bubbles 10
Banking Crises 14
Sovereign Debt Crisis 15
International Contagion 18
Chapter 3 The Credit Crisis of 2007–2009 24
Planting the Seeds of a Bubble: The Early 2000s 25
Wall Street’s Role 27
The U.S. Government Takeover of the GSEs 30
The Tipping Point: Lehman Brothers’ Failure 32
Aftermath of the Credit Crisis 35
Cost of Government Bailouts 37
Chapter 4 Systemic Risk, Economic and Behavioral Theories: What Can We Learn? 44
Minsky Three-Part Model 45
Debt Deflation Cycle 46
Benign Neglect 47
Behavioral Theories 48
Risk Aversion Bias 49
Asset Prices 50
Homogeneous Expectations versus Heterogeneity 51
Anchoring Heuristic 52
Excessive Optimism 52
Familiarity Bias 53
Fallacy of Composition 53
Fight or Flight 53
Chapter 5 Systemic Risk Data 59
Key Data Attributes 60
Key Policy Changes to Address Data Gaps 60
Data Sources 63
Data Collection Challenges and Remaining Gaps 63
Move Toward Standardization: Legal Entity Identifier Initiative 68
Chapter 6 Macroprudential versus Microprudential Oversight 73
A Comparison of Macroprudential versus Microprudential 74
Microprudential Policies 74
Macroprudential Policies 76
A Historical Perspective on Macroprudential Tools 77
Choice of Macroprudential Policy Tools 79
Chapter 7 Introduction to the U.S. Regulatory Regime 84
Who Are the Regulators? 84
U.S. Regulatory Approaches 86
Comparison of U.S. versus International Financial Regulatory Regimes 87
Introduction to the Dodd-Frank Act 90
Chapter 8 Introduction to International Regulatory Regimes 97
The Financial Stability Board 97
The Basel Accords 99
The European Systemic Risk Board 99
Principles for Financial Market Infrastructures 102
Chapter 9 Systemically Important Entities 107
Introduction to Systemically Important Entities 107
Classification of Entities as Systemically Important by the FSOC 108
Bank SIFIs 110
Nonbank SIFIs 110
SIFMUs 112
Globally Systemically Important Banks 112
Total Loss-Absorbing Capacity (TLAC) Requirements 114
Broad Impact of Financial Stability Requirements 117
Chapter 10 The Volcker Rule 120
Introduction to the Volcker Rule 120
The Volcker Rule: Details 122
Prohibition of Proprietary Trading 123
Prohibition of Ownership or Sponsorship of Hedge Funds and Private Equity Funds 123
The Volcker Rule and Systemically Risky Nonbank Financial Companies 123
Activities That Are Permitted Despite the Volcker Rule 124
Implementation of the Volcker Rule 125
Volcker Rule: Criticism 126
Chapter 11 Counterparty Credit Risk 130
Overview of Derivative Securities 130
Counterparty Exposure 133
How Counterparty Credit Risk Is Managed 136
Collateral 136
Netting 136
Central Counterparties 139
Counterparty Credit Risk and Systemic Risk 142
Chapter 12 The Dodd-Frank Act and Counterparty Credit Risk 147
Measuring Counterparty Exposure in the OTC Derivatives Market 147
Overview of Historical Data 149
The Evolution of the U.S. Regulatory Approach toward OTC Derivatives 152
Key Provisions of Title VII of the Dodd-Frank Act 153
Mandatory Clearing 154
Execution Platforms and Data Repositories 154
Registration Requirements 155
The Push-Out Rule 155
The End User Exemption 155
Criticism of Title VII of the Dodd-Frank Act 155
Chapter 13 The Basel Accords 159
What Are the Basel Accords? 159
The Approach of the Basel Accords 160
Basel I 161
Basel II 163
Pillar 1: Minimum Capital Requirements 163
Pillar 2: Supervisory Review 164
Pillar 3: Market Discipline 165
Basel II. 5 165
Basel III 165
The Continuing Evolution of the Basel Accords 166
Chapter 14 Lender of Last Resort 169
Lender of Last Resort Concept 169
Henry Thornton, Walter Bagehot, and Alternative Views 170
The Fed’s Role in the Great Depression 172
The Credit Crisis of 2007–2009 173
Chapter 15 Interconnectedness Risk 177
A Case Study of Interconnectedness 178
Interconnectedness Categories 179
The Depository Trust & Clearing Corporation 180
Post-Crisis Regulatory View of Interconnectedness 181
Basel Committee on Banking Supervision 181
Office of Financial Research 182
CPMI IOSCO Principles 184
An Approach to Analyzing Interconnectedness Risk 185
The Depository Trust & Clearing Corporation 185
Chapter 16 Conclusion: Looking Ahead 190
It’s Not a Question of If, but When, Where, and How 192
A Summary of Global Surveys 192
Sources of Systemic Risk 193
Preparing for the Next Crisis 194
Appendix: Systemic Risk Models 198
Structural versus Reduced-Form Credit Models 198
Contingent Claims and Default Models 199
Merton versus Garch 204
Studies in Support of Merton 205
Macroeconomic Measures 210
Probability Distribution Measures 211
Illiquidity Measures 214
Counterparty Risk Measures 215
Behavioral Models 217
Solutions to the Knowledge Check Questions 223
Index 239
About the Author :
ARON GOTTESMAN is Professor of Finance and the chair of the Department of Finance and Economics at the Lubin School of Business at Pace University. He is widely published in academic journals and is the author of Derivatives Essentials: An Introduction to Forwards, Futures, Options, and Swaps.
MICHAEL LEIBROCK is managing director, chief systemic risk officer, and head of Counterparty Credit Risk for The Depository Trust & Clearing Corporation (DTCC). He serves as chair of DTCC’s Model Risk Governance Committee and co-chair of the Systemic Risk Council, and is an active speaker globally on the topics of systemic and credit risk.
