Exploring Systemic Risk of Chinese SIFIs Using a Simplified SRISK Model/Explorando o Risco Sistemico de SIFIs Chineses usando um Modelo SRISK Simplificado.
| Autor | Haider, Muhammad Jamal |
1. Introduction And Literature Review
1.1. Defining Systemic Risk
After the financial crisis of 2008, systemic risk's popularity surged as academics raced to explain its inner workings, this transgressed the usual academic segregation and materialised in widespread interdisciplinary attention. Especially because some aspects of the banking industry make it more susceptible to systemic risk, and thus their failure a more problematic event for the whole economic system. According to Bullard et al. (2009), these are a high level of interconnectedness, high leverage ratios, which both are inherent to the nature of the financial industry, and a maturity mismatch at its core activity between its debit and credit transactions. It is this liquidity providing activity that presents bank's main value added function. And, similarly, it is the failure to provide this service to an economy that partly relies on it that can have the most adverse effects. In times of strong financial globalisation and increasing interconnectedness of banks, susceptibility to system failure increases as well. Calluzzo and Dong (2015) confirmed the changing nature of the banking system. The authors conclude that while individually, banks were able to increase their financial soundness, collectively they gained vulnerability.
A comprehensive definition of systemic risk for financials can be found in Acharya, Engle, and Richardson (2012), who collected three main components and the product accurately reflects what systemic risk implies for a firm and its stakeholders. Those three components are the costs to society in terms of capital shortfall, the likelihood that the crisis event happens, and the capital shortfall a firm can expect should such an event happen. Building up on the works of Bernanke (1983), Slovin et al. (1993), Thakor (1996), Holmstrom and Tirole (1997), and empirical workings of Gibson (1995), the three authors identified two overarching ideas behind systemic risk: (1) if there is not sufficient capital, performing financial services is impossible and (2) that systemic risk only becomes important when it affects the whole economy. This study will use this definition, as it contains the key characteristics that are useful within the scope of this thesis, namely that in times of capital shortfall within the system financial services are inhibited, which in turn has a real effect on the overall, broader economy.
The single, individual elements of systemic risk are more difficult to narrow down, and no comprehensive definition has so far emerged (Bisias et al., 2012; Galati & Moessner, 2010). The researchers find that the definitions usually portray only ever one specific aspect of systemic risk. Eijffinger's (2011) collection of systemic risk definitions finds that they all show at its core an impairment of the material workings of the financial industry, usually by a loss of confidence and increased uncertainty. Building on this, Smaga (2014) found four key elements that describe systemic risk. Firstly, systemic risk affects a large part of the financial system and impairs the working of this system. Secondly, shocks--usually exogenous--move along the interconnected system and negatively affect the overall economy. Thirdly, after the 2008 crisis, systemic risk has grown more popular. Lastly, the negative impact to the real economy is connected to the impairment of the financial functions that mostly happen only after the crisis. Comparing this to the definition of Acharya, Engle, and Richardson (2012), most elements are congruent and consistent with the findings of Smaga (2014). The key features of lacking liquidity and ability to performing financial services are, in fact, dominant features in most of the literature reviewed above. Acharya, Engle, and Richardson (2012) went beyond that and add an important distinction that serves both for practicality and ease of use, namely that systemic risk is only important when it threatens the wider economy. This does not mean that it should be ignored in times of economic upswing. In addition to that, it should be pointed out that systemic risk is not an excuse to provide banks with unlimited capital; these still need to fail for efficient markets to be able to function. The distinction adds, however, an important perspective that banking failure should be measured in terms of its real effect on the economy, as to avoid interfering with the efficiency incentive failures bring to the whole economic system.
When looking at systemic risk, it is often beneficial to focus at the biggest and most connected firms in the system, as these are most likely to have the biggest adverse impact on the system should it come to a crisis situation, for example, if these turn out to be undercapitalised and in need of a bailout. This study aims to analyse five Chinese financial services companies systemically important to the whole sector and indeed global markets. These SIFIs, as defined by the financial stability board (FSB), are institutions, which if failing would have significant effects on the broader economy. This definition is aligned with the two major characteristics of the definition of systemic risk employed in this study (1) the failure to perform financial services and (2) its impact on the wider economy.
12. Systemic Risk in China
The New York University's (NYU) Volatility Lab (V-LAB) features Chinese systemic risk indices prominently. This is no surprise considering that the Chinese economy grew from the last decade at an unmatched speed. Economic theory suggests that on each upswing follows a downturn, and it is in those downturns that banks who fall short of capital create a systemic risk threat to the whole economy. Now, China is a special case that requires a great deal of attention to detail, as many of the nuances do not align with those of the US or European markets.
Most of the research from China focuses on macroprudential measure and policy regulation implications of systemic risk, as well as the question of interconnectedness. Few studies look at tail losses and expected shortfall. The principle of marginal shortfall has been applied and found working in its bases. Fan, Wang, and Fang (2011) applied the MES and SES measure to Chinese institutions and empirically verify that in crisis situations higher MES correlates with higher SES. Gao and Pan (2012) looked at the risk of contagion for Chinese banks in the year of 2009. The authors' scrutinised possible ways systemic risk could spread and look at implications for liquidity and creditworthiness. The researchers find contagion within a concentrated version of their sample, especially for BOC and ICBC. They further find that the capital adequacy ratio and risk exposure are two important factors determining how a bank is affected in a crisis situation. Also focussing on contagion, Li and Meng (2012) illustrated that reserve requirements are by far the most powerful tools preventing contagion. The authors suggested that other risk control tools should follow suit. Similarly, Ma, Fan, and Cao (2007) looked at balance sheet information and interconnectedness as a gauge for systemic risk.
One aspect specific to systemic risk in China is the predominant shadow banking sector. Hsu, Li, and Xue (2014) found that during China's shift toward a modern banking system many informal lending practises were left unapprised for risk. Indirectly linked by credit guarantors, banks may face unforeseen losses connected to the informal industry. Exacerbated is this by the perception that the government guarantees deposits of the formal banks. The authors found that, for example, trust companies contributed greatly to systemic risk because of their high level of liabilities and interconnectedness with other institutions.
Bekaert and Harvey (1997) suggested another indication at how emerging financial markets behave differently from more developed capital markets. Amongst other findings, the authors confirmed empirically that with capital market liberalisation, volatility in those markets decreases. The authors further suggested that world events have a bigger say in developed capital markets, while local events play a more important role in more closed markets. While seemingly obvious, this implies an important mean of caution when analysing China's capital markets for systemic risk. For that, one should take into account the stages of development of the country's capital market during the timeframe considered in the analysis.
1.3. SRISK and Other Models
Early approaches to systemic risk were made by Acharya (2001), who laid out the theoretical framework for a systemic risk way of looking at banking regulation, long before the defining crisis of the 21st century hit. He discovered that banks usually act together when the negative effects of the potential crisis outweigh the potential gains that can be made from a potential reduction in competition due to failures during the crisis. In his findings, the author suggested that banks should be incentivised to diversify by means of taxation and conditional bailouts by central banks. In subsequent researches, the author together with other authors from NYU Stern's Volatility Lab, analyse the implications and viability of volatility measures, which should eventually create the SRISK analysis as means of capturing the amount of capital a firm will lack conditioned on an overall market downturn.
SRISK aims to internalise some externalities of systemic risk and provide the grounds for macro-prudential regulation that make bank failures obsolete as at any time the institutions within the system hold enough capital to avoid contagion and step in to provide the services the failing bank falls short of (Acharya, 2001). Such preemptive means of regulation have the obvious advantage that the probability of a real capital shortfall is greatly reduced, but many of the implications this will have on banks...
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