This paper proposes a threefold test that indicates which financial institutions are systemically important across the various industry segments. The recent financial crisis has revealed substantial deficiencies in the regulation and supervision of the international banking sector. Comprehensive reform packages like Basel III or the Dodd-Frank Act in the United States have been established to improve the resilience of the banking sector in general, and particularly in times of financial or economic distress.
Key measures of these reforms include a substantial increase of capital requirements, both in quantitative and qualitative terms, and the introduction of internationally harmonised liquidity standards. Furthermore, improvements were made in risk management and governance processes, and the transparency measures and disclosure procedures of the institutions were strengthened. Financial institutions have been characterised as systemically important if their distress or disorderly failure would cause significant disruption to the financial system and economic activity due to their size, complexity and systemic interconnectedness.
The negative externalities of a SIFI failure would also inflict damage on the real economy through multiple channels. SIFIs are expected to have higher loss-absorbency capacities and are subject to more intensive supervision and resolution planning in order to reduce moral hazard and to take into account the specific relevance of SIFIs for the stability of the global financial system. Regulatory practice currently follows indicator-based approaches that are applied to the banking and insurance sectors to identify global systemically important banks G-SIBs and global systemically important insurers G-SIIs.
These indicators include, for example, the size of banks, their interconnectedness, the lack of readily available substitutes for services or infrastructures they provide, their global activity and their complexity. All are deemed important indicators to measure the global systemic importance of banks. Each bucket represents the level of systemic importance in descending order and determines the required level of additional common equity loss absorbency as a percentage of risk-weighted assets that applies to each G-SIB.
The additional capital requirements range from 3. Furthermore, as of November , nine insurance groups have qualified as G-SIIs that are subject to higher loss absorbency requirements and further policy measures. A failure in any of these institutions could equally trigger instability in the financial system.
It is particularly challenging to find a common methodology for identifying such non-bank non-insurer NBNI financial institutions as globally systemically important, due to the fact that their underlying business models, risk profiles and transmission channels are very heterogeneous. A growing number of research publications have emerged that deal with financial networks as a means to better understand the interconnections among financial institutions and their relevance for systemic risk.
However, there are still several issues to be resolved, such as data requirements and empirical testing of underlying model assumptions before they might be used in practice by regulatory authorities. The methodology to identify SIFIs outlined in this proposal is based on the assumption that a SIFI is systemically important if it has: i global market relevance , ii a high level of risk potential , and iii a high level of interconnectedness with other financial institutions.
As an initial filter for selecting financial institutions to be tested, a minimum threshold for total assets could be applied.
This implies that financial institutions with total assets below this limit would be considered too small to have a systemic impact if they were to fail. Accordingly, this paper proposes a threefold indicator-based SIFI test along the three dimensions outlined above: a market relevance test , a risk potential test and an interconnectedness test.
The test should be repeated on a regular basis. The rationale behind the first test is that a SIFI is assumed to have global market relevance and therefore a leading position in most of its core markets. Depending on the business model and product offering, global market relevance could either be reflected by leading positions in global markets e. If this is the case, the conclusion that a failure would significantly affect a large customer base appears to be reasonable.
To conduct the market relevance test, market shares in each core market of the respective financial institution must be measured. Table 1 illustrates a possible segmentation for banking, insurance and NBNI here represented by asset management Note that the respective market shares should be calculated for different regional markets where appropriate, e.
The test examines whether a potential SIFI has a market share above a certain critical market share in its defined market segments. The calibration of the respective critical market share should be subject to a detailed market concentration analysis per product line and region, possibly using a Lorenz curve.
Moreover, a cut-off point for the cumulative share of the largest financial institutions must be defined, depending on the respective market structure, to calculate the critical market shares. The respective financial institution would be classified as a SIFI subject to the outcome of the other two tests if the test reveals that the market shares are equal to or greater than the respective critical market share for either at least one product line in all major economic regions for regional markets or at least one global market.
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