Can We Prove a Bank Guilty of Creating Systemic Risk? A Minority Report
27 Pages Posted: 19 Nov 2015 Last revised: 16 Feb 2016
Date Written: November 17, 2015
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
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