An Early Warning Tool for Measuring the Build-Up of Systemic Risks in Banks and Financial Systems

26 Pages Posted: 17 May 2016

See all articles by Piet De Jong

Piet De Jong

Macquarie University - Department of Applied Finance and Actuarial Studies; Financial Research Network (FIRN); Macquarie University, Macquarie Business School

Weihao Choo

Macquarie University - Department of Applied Finance and Actuarial Studies

Geoffrey Loudon

Macquarie University

Date Written: May 10, 2016

Abstract

This paper develops, analyses and implements an early warning tool for systemic risk in banks and financial entities. The tool is based on a refined approach to stress testing. Calculations performed on Australian bank data are shown to predict past distress. Risk is measured as a function of expected capital shortfall in individual firms. A simple model of regulatory capital is assumed. Systemic risk is shown to be driven by the size and leverage of balance sheets and interdependence between firms. Firm balance sheets are modelled using publicly available information and assumed to depend on market returns. Model refinements using more comprehensive information and practical implementation are also discussed.

Suggested Citation

De Jong, Piet and Choo, Weihao and Loudon, Geoffrey, An Early Warning Tool for Measuring the Build-Up of Systemic Risks in Banks and Financial Systems (May 10, 2016). CIFR Paper No. 109/2016. Available at SSRN: https://ssrn.com/abstract=2780718 or http://dx.doi.org/10.2139/ssrn.2780718

Piet De Jong (Contact Author)

Macquarie University - Department of Applied Finance and Actuarial Studies ( email )

Sydney, New South Wales
Australia

Financial Research Network (FIRN)

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

HOME PAGE: http://www.firn.org.au

Macquarie University, Macquarie Business School ( email )

New South Wales 2109
Australia

Weihao Choo

Macquarie University - Department of Applied Finance and Actuarial Studies ( email )

North Ryde
Sydney, New South Wales 2109
Australia

Geoffrey Loudon

Macquarie University ( email )

New South Wales 2109
Australia

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