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Can We Prove a Bank Guilty of Creating Systemic Risk? A Minority Report

27 Pages Posted: 19 Nov 2015 Last revised: 16 Feb 2016

Jon Danielsson

London School of Economics - Systemic Risk Centre

Kevin R. James

London School of Economics; Financial Conduct Authority

Marcela Valenzuela

University of Chile

Ilknur Zer

Federal Reserve Board

Date Written: November 17, 2015

Abstract

Since increasing a bank's capital requirement to improve the stability of the financial system imposes costs upon the bank, a regulator should ideally be able to prove beyond a reasonable doubt that banks classified as systemically risky really do create systemic risk before subjecting them to this capital punishment. Evaluating the performance of two leading systemic risk models, we show that estimation error alone prevents the reliable identification of the most systemically risky banks. We conclude that it will be a considerable challenge to develop a riskometer that is both sound and reliable enough to provide an adequate foundation for macroprudential policy.

Keywords: Systemic risk, macroprudential policy, financial stability, risk management

JEL Classification: G01, G10, G18, G20, G28, G32, G38

Suggested Citation

Danielsson, Jon and James, Kevin R. and Valenzuela, Marcela and Zer, Ilknur, Can We Prove a Bank Guilty of Creating Systemic Risk? A Minority Report (November 17, 2015). Journal of Money, Credit, and Banking, Forthcoming. Available at SSRN: https://ssrn.com/abstract=2692086 or http://dx.doi.org/10.2139/ssrn.2692086

Jon Danielsson

London School of Economics - Systemic Risk Centre ( email )

Houghton Street
London WC2A 2AE
United Kingdom
+44.207.955.6056 (Phone)

HOME PAGE: http://www.riskreasearch.org

Kevin Roger James (Contact Author)

London School of Economics ( email )

Houghton Street
London, WC2A 2AE
United Kingdom

Financial Conduct Authority ( email )

25 The North Colonnade
London, E14 5HS
United Kingdom

Marcela Valenzuela

University of Chile ( email )

Pío Nono Nº1, Providencia
Santiago, R. Metropolitana 7520421
Chile

Ilknur Zer

Federal Reserve Board ( email )

20th Street and Constitution Avenue NW
Washington, DC 20551
United States

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