Designing an Expert Knowledge-Based Systemic Importance Index for Financial Institutions

Borradores de Economia, No. 669, 2011

41 Pages Posted: 7 Jul 2012

See all articles by Carlos León

Carlos León

Banco de la República (Central Bank of Colombia); Tilburg University - Center for Economic Research (CentER)

Clara Machado

affiliation not provided to SSRN

Date Written: September 1, 2011

Abstract

Defining whether a financial institution is systemically important (or not) is challenging due to (i) the inevitability of combining complex importance criteria such as institutions’ size, connectedness and substitutability; (ii) the ambiguity of what an appropriate threshold for those criteria may be; and (iii) the involvement of expert knowledge as a key input for combining those criteria. The proposed method, a Fuzzy Logic Inference System, uses four key systemic importance indicators that capture institutions’ size, connectedness and substitutability, and a convenient deconstruction of expert knowledge to obtain a Systemic Importance Index.

This method allows for combining dissimilar concepts in a non-linear, consistent and intuitive manner, whilst considering them as continuous –non binary- functions. Results reveal that the method imitates the way experts them-selves think about the decision process regarding what a systemically important financial institution is within the financial system under analysis.

The Index is a comprehensive relative assessment of each financial institution’s systemic importance. It may serve financial authorities as a quantitative tool for focusing their attention and resources where the severity resulting from an institution failing or near-failing is estimated to be the greatest. It may also serve for enhanced policy-making (e.g. prudential regulation, oversight and supervision) and decision making (e.g. resolving, restructuring or providing emergency liquidity).

Keywords: systemic importance, systemic risk, fuzzy logic, approximate reasoning, too-connected-to-fail, too-big-to-fail

JEL Classification: D85, C63, E58, G28

Suggested Citation

León, Carlos and Machado, Clara, Designing an Expert Knowledge-Based Systemic Importance Index for Financial Institutions (September 1, 2011). Borradores de Economia, No. 669, 2011. Available at SSRN: https://ssrn.com/abstract=2101225 or http://dx.doi.org/10.2139/ssrn.2101225

Carlos León (Contact Author)

Banco de la República (Central Bank of Colombia) ( email )

Bogotá
Colombia

Tilburg University - Center for Economic Research (CentER) ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands

Clara Machado

affiliation not provided to SSRN

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