Assessing the Systemic Implications of Financial Linkages

IMF Global Financial Stability Report, Vol. 2, April 2009

38 Pages Posted: 12 Jun 2009

See all articles by Jorge A. Chan-Lau

Jorge A. Chan-Lau

International Monetary Fund (IMF) - International Capital Markets Department; National University of Singapore (NUS) - Risk Management Institute; Tufts University - Fletcher School of Law and Diplomacy

Marco Espinosa

affiliation not provided to SSRN

Kay Giesecke

Stanford University - Management Science & Engineering

Juan A. Solé

International Monetary Fund (IMF)

Date Written: April 1, 2009

Abstract

The rise in the complexity and globalization of financial services has contributed to stronger interconnections or linkages. While more extensive linkages contribute to economic growth by smoothing credit allocation and allowing greater risk diversification, they also increase the potential for disruptions to spread swiftly across markets and borders. In addition, financial complexity has enabled risk transfers that were not fully recognized by financial regulators or by institutions themselves, complicating the assessment of counterparty risk, risk management, and policy responses. Thus the importance of assessing the systemic implications of financial linkages.

This chapter illustrates the type of methodologies that can provide some prospective metrics to facilitate discussions on systemic linkages and, specifically, the “too-connected-to-fail” problem, thereby contributing to enhanced systemically focused surveillance and regulation.

Though these methodoloies have limitations, together they represent a set of valuable surveillance tools and can form the basis for policies to address the too connected- to-fail problem, specifically in two areas:

• Perimeter of regulation. To maintain an effective perimeter of prudential regulation without stifling innovation, the tools provided in the chapter could help address questions such as whether to limit an institution’s exposures, the desirability of capital surcharges based on systemic linkages, and the merits of additional liquidity regulations.

• Information gaps. The chapter also discusses the importance of filling existing information gaps on cross-market, cross-currency, and cross-country linkages to refine analyses of systemic linkages. Closing information gaps would require improved data collection procedures and impose additional demands on financial institutions, but would be a far better alternative to waiting until a crisis ensues to obtain information as events unfold.

Keywords: financial crisis, interconnectedness, network analysis, corisk, default intensity, perimeter of regulation, information gaps

JEL Classification: G20, G18, F36

Suggested Citation

Chan-Lau, Jorge Antonio and Espinosa, Marco and Giesecke, Kay and Sole, Juan A., Assessing the Systemic Implications of Financial Linkages (April 1, 2009). IMF Global Financial Stability Report, Vol. 2, April 2009. Available at SSRN: https://ssrn.com/abstract=1417920

Jorge Antonio Chan-Lau

International Monetary Fund (IMF) - International Capital Markets Department ( email )

700 19th Street NW
Washington, DC 20431
United States

National University of Singapore (NUS) - Risk Management Institute ( email )

21 Heng Mui Keng Terrace
Level 4
Singapore, 119613
Singapore

Tufts University - Fletcher School of Law and Diplomacy ( email )

160 Packard Ave
Medford, MA 02155
United States

HOME PAGE: http://fletcher.tufts.edu/ceme/index.shtml

Marco Espinosa (Contact Author)

affiliation not provided to SSRN

Kay Giesecke

Stanford University - Management Science & Engineering ( email )

473 Via Ortega
Stanford, CA 94305-9025
United States
(650) 723 9265 (Phone)
(650) 723 1614 (Fax)

HOME PAGE: http://www.stanford.edu/~giesecke/

Juan A. Sole

International Monetary Fund (IMF) ( email )

700 19th Street N.W.
Washington, DC 20431
United States

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