Analysing systemic risk in banking and financial markets
| Date | 01 January 1997 |
| Published date | 01 January 1997 |
| DOI | https://doi.org/10.1108/eb024903 |
| Pages | 37-48 |
| Author | Atul K. Shah |
| Subject Matter | Accounting & finance |
Journal of Financial Regulation and Compliance Volume 5 Number 1
Analysing systemic risk
in
banking and financial
markets
Atul
K.
Shah
Received:
9th
August, 1996
AFM Department, University
of
Essex, Wivenhoe, Colchester CO4 3SQ; tel. 1206 873813,
e-mail: ashah@essex.ac.uk
Dr Atul K. Shah
is a
Lecturer
in
the Department
of Accounting, Finance and Management
at
the
University
of
Essex.
He
obtained
his
PhD from
the London School
of
Economics
in
1993,
and
has since taught
at the
Universities
of
Bristol
and Maryland.
His
research interests
are
prin-
cipally
in the
regulation
of
corporate and finan-
cial institutions and markets.
ABSTRACT
The deregulation
of
international banking
and
financial markets
has
raised
a
number
of
con-
cerns about their fragility
and
risk
of
collapse
through systemic contagion.
A
large amount
of
research
has
been conducted
to
explore policy
solutions
to
this problem. However, there
is
little work
in the
literature which attempts
to
understand
the
various components and dimen-
sions
of
systemic
risk.
This paper develops
a
comprehensive understanding
of
systemic
risk,
by using
the
theoretical
framework provided
by
Perrow
in his
seminal book, 'Normal Acci-
dents'.1
It
elaborates
and
exposes three
of
the
central components
—
risk,
complexity
and
coupling, which together make
the
modern
global financial system significantly fragile.
It
is hoped that this understanding will create
a
common
basis
for future discussions
of
systemic
risk
and
also help towards developing policy
reforms.
BACKGROUND
In recent years, there have been
a
number
of
financial scandals
and
shocks which have
affected financial institutions and markets.
One
of the primary motivations
for
regulation
is to
prevent such shocks from spilling over
and
leading
to the
collapse
of
other financial insti-
tutions
— a
phenomenon commonly under-
stood
as
systemic risk.
In the
last
two
decades,
the financial services industry
has
undergone
a
significant revolution
in
terms
of
structural
changes
and
product innovations,
and the
speed with which
the
change
has
come about
is
now a
cause
for
concern among bank regu-
lators from
all
over
the
world.
Not
only
is
systemic risk
a
domestic concern,
but it has
now also become
an
international concern.
Globalisation
and the
resulting connections
between international financial institutions
and
markets
has
also meant that financial collapses
in
one
country
can
also have ripple effects
in
other countries. The
Economist
ran a
cover fea-
ture
on
'How safe
is
your bank?',2 explaining
how serious
a
public policy issue systemic risk
has become. Financial rescues
of
ailing banks
to avert systemic collapse
can
cost several mil-
lions
of
pounds
(at
times going into billions),
hence there
is a
real need
for
research
in
this
area.
There
is a
widespread acceptance
in the
banking
and
finance literature that systemic
risk exists
in
banking and
is a
cause
for
serious
public policy concern. Dale explains that there
are several factors which contribute
to the
inherent fragility
of
all banks.3 These are:
— their high leverage, with
a
significantly
higher amount
of
debt than equity
—
the
difficulty
in
converting underlying
assets into cash
in a
reasonably short time
Journal
of
Financial Regulation
and Compliance, Vol.
5.
No.
1.
1997,
pp. 37-48
© Henry Stewart Publications,
1358-1988
Page 37
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