Looking for grassroot sources of systemic risk

Abstract

The global financial system has become highly connected and complex. It has been proved in practice that existing models, measures and reports of financial risk fail to capture some important systemic dimensions. Recently, advisory boards have been established at a high level, and regulations are being directly targeted at systemic risk. In the same direction, a growing number of researchers employ network analysis to model systemic risk in financial networks. Current approaches are concentrated on interbank payment network flows at national and international levels. This work builds on existing approaches to propose systemic risk assessment at the micro level. The proposed model (partially) captures the systemic aspect of credit risk of bank customers and argues that this part of risk is neglected in both credit scoring models and interbank systemic risk calculations. In particular, the analysis of intra-bank financial risk interconnections is introduced by examining the real case of a ‘receivables-as-collateral’ network. In the data set examined, an initial failure of five customers, representing 17 per cent of the network’s total value, results in the subsequent failure of 15 customers, representing 41 per cent of the total value. The author’s model could be complementary to existing credit scoring models that account for mainly idiosyncratic customers’ financial profiles. Private or public organisations could further elaborate the specification to include a wider range of parameters, such as transactions on contracts, assets and cash flows. Identification of the systemic risk could be beneficial for a business entity in assessing unexplored sources of risks in its portfolios of assets and customers. Understanding and modelling these ‘particles’ of risk could enable more realistic monitoring and the provision of early warning messages for market supervising bodies.