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Το κύριο σώμα της παρούσας διπλωματικής εργασίας, έχει ως σκοπό να μελετήσει τη χρήση της Du Pont Analysis και της μεθοδολογίας Camels, την αποτελεσματικότητα και την αποδοτικότητα των παγκόσμιων συστημικών τραπεζών και να κάνει μια συγκριτική ανάλυση πριν και μετά την παγκόσμια οικονομική κρίση που εμφανίστηκε σε ολόκληρο τον κόσμο με σκοπό να προσπαθήσουμε να καταλάβουμε γιατί αυτές οι τράπεζες επιλέγονται ως συστημικές στην παγκόσμια οικονομία.
Η ανάλυση των τραπεζικών κρίσεων, της αποτελεσματικότητας και της κερδοφορίας ήταν κατά καιρούς η μελέτη πολλών ερευνητών σε ολόκληρο τον κόσμο. Η DuPont μετρά τον πλούτο των μετόχων με το δείκτη ROE και την αποτελεσματικότητα της διαχείρισης με το δείκτη ROA, με αποτέλεσμα να παρατηρούμε τον ένα δείκτη να επηρεάζει τον άλλο. Από την άλλη, οι δείκτες Camels παρέχουν για την κάθε τράπεζα μια βαθμολογία της συνολικής απόδοσης και έξι επιμέρους βαθμολογίες για κάθε κατηγορία αριθμοδείκτη ξεχωριστά. Δηλαδή, μας παρέχουν την δυνατότητα να διακρίνουμε παράγοντες που συμβάλλουν στην χρεοκοπία μιας τράπεζας. Ουσιαστικά, συγκρίνεται ο σχηματισμός ενός συγκρίσιμου μεγέθους, τόσο μεταξύ των επιμέρους τραπεζών, όσο και κατά την πάροδο του χρόνου.
Γίνεται ανάλυση των παγκόσμιων συστημικών τραπεζών με βάση την DuPont Analysis και την Camels, για το χρονικό διάστημα των οχτώ (8) ετών. Αυτό σημαίνει τρία χρόνια πριν από την παγκόσμια οικονομική κρίση (2005-2007) και πέντε χρόνια μετά την οικονομική κρίση (2008-2012). Οι οικονομικές πληροφορίες που χρησιμοποιούνται έχουν ληφθεί από τις διαθέσιμες δημοσιευμένες οικονομικές καταστάσεις των Παγκόσμιων συστημικών τραπεζών, το Διοικητικό Συμβούλιο Χρηματοπιστωτικής Σταθερότητας (FSB) και GFIs.
Στο πρώτο κεφάλαιο, αναφερόμαστε στον ρόλο του Συμβουλίου Χρηματοπιστωτικής Σταθερότητας (Financial Stability Board), στην Επιτροπή Βασιλείας για την εποπτεία των τραπεζών (BCBS), και αναλύουμε τις παγκόσμιες συστημικές τράπεζες, ποιες είναι αυτές που τελικά επηρεάζουν και υποστηρίζουν την οικονομία. Στο δεύτερο κεφάλαιο, αναφερόμαστε στο θεσμικό πλαίσιο, τις ελλείψεις και τις επιπτώσεις της Βασιλείας ΙΙΙ. Στο τρίτο κεφάλαιο, θα εξηγήσουμε τη μεθοδολογία που χρησιμοποιήθηκε από την DuPont Analysis και την Camels. Επίσης, παρουσιάζονται οι ορισμοί, οι πίνακες και τα διαγράμματα όπου και παραθέτουμε τα αποτελέσματα των παγκόσμιων συστημικών τραπεζών για την κερδοφορία τους με βάση των μεθοδολογιών που χρησιμοποιήθηκαν. Τέλος, δίδονται τα συμπεράσματα της εργασίας αυτής.

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3. The Results of DuPont Analysis

In this paper we present the course of profitability ratios during 2005-2012 of the following 24^th World Systemic Banks using the DuPont Analysis. All the calculations in the bellow tables (2-25) became using the publication of the financial statements of the world systemic banks. Some financial elements have drawn from Bank scope and Bloomberg data bases.

1. DEUTSCHE BANK

2. HSBC

3. BARCLAYS

4. BNP PARIBAS

5. BANK OF NEW YORK MELLOW

6. CREDIT SUISSE

7. MORGAN STANLEY

8. ROYAL BANK OF SCOTLAND

9. UBS

10. NORDEA

11. SOCIETE GENERALE

12. CITIGROUP

13. JP MORGAN CHASE

14. BANK OF AMERICA

15. BANK OF CHINA

16. BBVA

17. CREDIT AGRICOLE

18. ING GROUP

19. STANTANDER

20. STATE STREET CORPORATION

21. UNICREDIT GROUP

22. WELLS FARGO

23. MIZUHO FG

24. SUMITOMO

The results of profitability of it’s of the above global systemic bank are described below.

From the tables and diagrams in the Appendix we can distinguish 5 main categories for the course of ROE ratio.

1. Stable but low course of ROE ratio. The first category comprises four banks. These banks are Deutsche Bank, Barclays, Morgan Stanley, and Unicredit Group.

2. Fluctuations with a negative rate of ROE after the financial crisis. The second category includes nine banks. These banks are New York Mellon, Credit Agricole, ING, Mizuho FG, Credit Suisse, UBS, Royal Bank of Scotland, Société Générale, and Citigroup.

3. Fluctuations with a negative rate of ROE before the financial crisis. The third category has three banks. These banks are HSBC, BNP Paribas, and Sumitomo.

4. Fluctuations with a positive rate of ROE before and after the financial crisis. The fourth category includes five banks. These banks are Nordea, Bank of China, Banco de Santander, State Street Corporation and Wells Fargo.

5. Downward trend of the index ROE before the financial crisis. The fifth category comprises three banks. These three banks are JP Morgan Chase, Bank of America and BBVA.

From the diagrams below we also observe that the ROA ratio prices of all of the banks are between -7% to +5%.

Conclusions

This paper presents a model for the financial analysis of a bank based on the DuPont system of financial analysis as presented in Saunders (2000).

Equity returns are supplied to shareholders from banks who utilize shareholders’ capital to offer loans to the banks clients.

The DuPont model is an analysis that calculates the ROE ratio. The ROE ratio is decomposed into net profit margin, total asset turnover and the equity multiplier. The DuPont model also show us how many times ROE ratio is bigger than the ROA ratio.

This model is applied to World Systemic Banks which are the largest banks in the world. The DuPont system of financial analysis shows the impact of the financial crisis that hit the world and mainly the South Countries of Euro zone in 2008 on the financial performance of World Systemic Banks.

In its simplest form, we can say that if a bank wants to improve the ROE ratio the only choices has is to increase operating profits, become more efficient in using existing assets to generate sales, recapitalize to make better use of debt and/or better control the cost of deposit and lending money, or find ways to reduce the tax liability of the firm. Each of these choices leads to a different financial strategy.

For example, to increase operating profits one bank must either increase sales (in a higher proportion than the cost of generating those sales) or reduce expenses. Since it is generally more difficult to increase sales than it is to reduce expenses, a small bank can try to lower expenses by offering innovating products and a big bank can do this by mergers and acquisitions.

Alternatively, to become more efficient, one big bank must either increase sales with the same level of assets or produce the same level of sales with fewer assets. A big bank might then try to determine: 1) if it is feasible to expand hours by staying open later or on weekends, or 2) if a less expensive piece of equipment is available that could replace an existing (more expensive) piece of equipment, or 3) if there is a more practical way to produce and/or deliver services than is presently being used.

Further, big banks can determine if they are using deposits loans and investments wisely.

The ROE and ROA indexes are the most comprehensive measure of profitability of a bank. It considers the operating and investing decisions made as well as the financing and tax-related decisions.

In the future, the financial institutions should find different sources of profitability, since the intermediation spread is expected to fall as the economies stabilize, the interest rates fall and the competition among banks increase. The financial institutions should seek for these new sources of profitability in the retail banking and the asset management, while they should try to increase their market share. On the other hand they should control their operating expenses and expand their activities quite careful, in order to minimize their losses from bad loans.

Bibliography-References

Basel Committee on Banking Supervision (2011) “Global systemically important banks: Assessment methodology and the additional loss absorbency requirement” Consultative Document 7/2011.

Bodie, Z., Kane, A., and Alan, J.M., (2004) “Essentials of Investments” 5^th edition, McGraw-Hill, Irwin,.

Boissay Frederic, Collard Fabrice and Smets Frank (2013) “Booms and Systemic Banking Crises.”: Working Paper Series No 1514/february 2013

Boran Milan (2010) “Market Dynamics & Systemic Risk” June 4, 2010 23rd Australasian Finance and Banking Conference 2010 Paper

Brandy, M., Walker, J.,(2011) “What is an equity multiplier”, 2011

Collier W. H., McGowan, B. Mc., Muhammad, Jr. J., (2010) “Evaluating the impact of a rapidly changing economic environment on bank financial performance using the DuPont system of financial analysis”, Asia Pacific Journal of Finance and Banking Research Vol.4.No.4, 2010

CRMPG III (2008). “Containing Systemic Risk.”, The report of CRMPG III, August 6, 2008

Crosson, S., V., Belverd E., Needles, Jr., Belverd E., (2008) “Powers Marian Principles of accounting”. Houghton Mifflin, Boston 2008

Daula Tomas (2012). “Systemic Risk: Relevance, Risk Management Challenges and Open Questions”, June 2012

Ergungor Emre O. and Thomson James B. (2005) “Systemic Banking Crises” Federal Reserve Bank of Cleveland, issue 2/2005

Groppelli, Angelico A., Nikbakht Eh., (2000) “Finance”, 4th ed. Barron's Educational Series, Inc., 2000

Kaufman G., George, (2000). “Banking and currency crises and systemic risk.” Article provided by Federal Reserve Bank of Chicago in its journal Economic Perspectives Issue Q III Pages 9-28

Kaufman George G. and Scott Kenneth E. (2003). “What Is Systemic Risk, and Do Bank Regulators Retard or Contribute to It?” The Independent Review, v. VII, n. 3, Winter 2003, ISSN 1086-1653, Copyright © 2003, pp. 371– 391.

Kyriazopoulos G., Petropoulos D., (2011) “Do the Cross Border Mergers and Acquisitions of the Greek Banks in the Balkan area affect on the course of profitability efficiency and liquidity indexes of them”? EBEEC Conference Pitesti 2011

Liesz J. Tomas (2002) “Really Modified DuPont Analysis: Five ways to improve ROE” sbaer.uca.edu/research/sbida/2002/.../19.pd

Schwarcz Steven L. (2008). “Systemic Risk, Duke Law School Legal Studies”, Paper No. 163 Georgetown Law Journal, Vol. 97, No. 1, 2008

Scott, M., (2007) “Due Diligence Requirement in Financial Transactions”, Q finance, 2007.

Selvavinayagam, K., (1995) “Financial Analysis of banking institutions”, Fao Investment Centre occasional paper series No.1, 1995.

Sinickas, A., (2004) “How to do due diligence Research, Strategic Communication Management”,8 (4) 2004.

Saunders, Anthony (2000), Management of Financial Institutions, Third Edition, McGraw Hill.

Tripp, R., (2005) “Report on Banks, Accounting in Banks” 2005

Van Voorhis, K.R. (1981) “The DuPont Model Revisited: A Simplified Application to Small Business” Journal of Small Business Management, 19(2), p.45-51.

Vasiliou D., (1999) “Financial Management” Hellenic Open University Patra 1999

Wheler, R.D., (2009) “Surety Merger & Acquisition, Due Diligence”, Aon Risk Services Central, Inc. 2009

Willard, F.M., (1962) “The Origins of the Basic Inventions Underlying Du Pont's Major Product and Process Innovations, 1920 to 1950” Published Year 1962 ISBN: 0-87014-304-2

Woolridge J.R., Gray Gary, (2006) “Applied Principles of Finance” Workbook, Kendall Hunt Publishing 2006

Internet sites

www. investopedia.com

http://en.wikipedia.org/wiki/Systemic_risk

Basel Committee on Banking Supervision http://www.bis.org/publ/bcbs207.pdf

www.financialstabilityboard.org

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2. DuPont Analysis for Banks

The profitability of the banking sector, has improved significantly in the first seven years of the new millennium before the crisis start up. This was a result of the general reform of the banking system (write off of non-performing loans, privatization of state-owned banks, the introduction of modern banking techniques, credit expansion, and the introduction of the euro) and the high intermediation spread in these countries.[1]

The analysis of the financial statements of a business includes besides the selection of the appropriate index and the comparison, without which the resulting conclusions do not have any meaning and most probably they do not lead to the correct explanation. The comparison makes sense when it is done in relation to time and in relation to the similar businesses or the sector. This double comparison gives the capability of a more correct explanation of the indexes and consequently of the business condition (Papoulias, 2000).

Profitability of banks is measured mainly by two ratios. The Return on Equity (ROE) that increase the wealth of the shareholders and the Return on Assets (ROA) that show to the investors how cable is the bank management to yield earnings and how profitably use the hole assets of the bank.

Saunders (2000) provides a model of financial analysis for financial institutions that is based on the DuPont system of financial analysis return on equity model. The return on equity model disaggregates performance into the three components that determine return on equity: net profit margin, total asset turnover, and the equity multiplier. The profit margin allows the financial analyst to evaluate the income statement and the components of the income statement. Total asset turnover allows the financial analyst to evaluate the left-hand side of the balance sheet which is composed of the asset accounts. The equity multiplier allows the financial analyst to evaluate the right-hand side of the balance sheet which is composed of liabilities and owners equity.

Return on equity analysis provides a system for planning (budgeting) in addition to analyzing the financial institution’s performance. The net profit margin allows the analyst to develop a pro forma income statement. An abbreviated income statement would be composed of net income equal to revenues minus expenses. The financial planner can determine the projected revenue level needed to meet the target net income level. The total asset turnover ratio permits the analyst to determine the total asset level needed to generate the projected total revenue level. The total asset requirement can be used to project the pro forma levels of all of the asset accounts based on the target current asset to fixed asset level. The fundamental equation of accounting is that assets equal liabilities plus owners equity. The equity multiplier ratio can be used to determine the pro forma financial needs and the financial structure of the financial institution.[2]

Return on equity, ROE, is first decomposed into return on asset, ROA, and the equity multiplier, EM. Return on assets is decomposed into net profit margin and total asset turnover:

ROE = (ROA) (EM) and ROA = (NPM) (TAT). Where, ROE = return on equity, ROA = return on assets, EM = the equity multiplier, NPM = net profit margin and TAT = total asset turnover

Return on equity is net income divided by total equity capital and return on assets is net income divided by total assets. The equity multiplier is the ratio of total assets and total equity capital.

ROE = (NI) / (TEC)

ROA = (NI) / (TA)

EM = (TA) / (TEC)

Where, NI = net income

TA = total asset

TEC = total equity capital

The equation for finding ROE is as follow:

ROE = Net Profits / Total Equity (1)

Analyzing the specific index of efficiency of the shareholders total equity, we can find out if the purpose of achieving a satisfactory result has succeeded. When a bank has losses ROE index is negative. When a bank has losses and negative equity then the ROE ratio is also negative. This is because in the numerator we get the absolute value of the negative earnings (ie losses) of the bank.

The equation for finding ROA is as follow:

(3)

ROA = Net Profits / Total Assets. (2)

Analyzing the specific index we could:

·                     Compare the efficiency among the co-operative banks.

·                     Observe the efficiency through time.

·                     Compare efficiency of co-operative banks with the efficiency of the banking sector as a whole.

·                     Investigate the reasons of the changes through time.

2.1 The Formula of DuPont Analysis[3][4][5][6][7]

The DuPont system of financial analysis can be used to construct a financial plan for the bank. The DuPont system of financial analysis provides a means for the firm to monitor performance through the planning period and to post-audit the planning process.

DuPont comes from DuPont Corporation that started using this formula in 1920s. DuPont ratio analysis breaks down ROA (Return on Assets) and ROE (Return on Equity) into three basic components that determine profit efficiency, asset efficiency and leverage. This is an attempt to isolate the causes of strength and weakness in the firm’s performance. DuPont focuses on the expense control, assets utilization, and also debt utilization (Bodie, Zane; Alex Kane and Alan J. Marcus, 2004).

The Return on total-Assets can be broken into two components. It equals the product of the profit margin and total asset turnover ratio. Like the Return on total Assets, Return on Equity can be broken down into component parts to tell us why the level of return changes from year to year or why two banks’ returns on equity differ. The Return on Equity is identical to Return on total Assets multiplied by the Equity Multiplier. A bank’s Return on Equity may differ from one year to the next, or from a competitor’s, as a result of differences in profit margin, asset turnover, or leverage. Return on Equity directly reflects a bank’s use of leverage or debt. If a bank uses relatively more liabilities to finance assets, the Equity Multiplier will rise, and, holding other factors constant, the firm’s Return on Equity will increase. This leveraging of a bank’s Return on Equity implies only a greater use of debt financing. This breaking down of Return on total Assets, and Return on Equity into their component parts is what DuPont analysis is.

It is believed that measuring assets at gross book value removes the incentive to avoid investing in new assets. New asset avoidance can occur as financial accounting depreciation methods artificially produce lower ROEs in the initial years that an asset is placed into service. If ROE is unsatisfactory, the DuPont Analysis helps locate the part of the business that is underperforming.

The Return on Equity model disaggregates performance into the three components that determine Return on Equity: net profit margin, total asset turnover, and the Equity Multiplier. The profit margin allows the evaluation of the income statement and the components of the income statement. Total asset turnover allows the evaluation on the left-hand side of the balance sheet which is composed of the asset accounts. The Equity Multiplier allows the evaluation of the right-hand side of the balance sheet which is composed of liabilities and owners equity. Return on Equity analysis provides a system for planning (budgeting) in addition to analyzing the financial institution’s performance.

The net profit margin allows the development of a pro forma income statement. An abbreviated income statement would be composed of net income equal to revenues minus expenses. The financial planner can determine the projected revenue level needed to meet the target net income level. The total asset turnover ratio permits the determination of the total asset level needed to generate the projected total revenue level. The total asset requirement can be used to project the pro forma levels of all of the asset accounts based on the target current asset to fixed asset level. The fundamental equation of accounting is that assets equal liabilities plus owners equity. The Equity Multiplier ratio can be used to determine the pro forma financial needs and the financial structure of the financial institution.

DuPont analysis simplified is similar with ROE even though it uses its own formula to present the same results compiling together ROA and Equity Multiplier.

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[1] “Does the Cross Border Mergers and Acquisitions of the Greek Banks in the Balkan area affect on the course of profitability efficiency and liquidity indexes of them”? Kyriazopoulos G., Petropoulos D., EBEEC Pitesti 2011

[2] Collier W. H., McGowan, B. Mc., Muhammad, Jr. J., (2010) “Evaluating the impact of a rapidly changing economic environment on bank financial performance using the DuPont system of financial analysis

[3] Evaluating the impact of a rapidly changing economic environment on bank financial performance using the DuPont system of financial analysis, Henry W. Collier, Carl B. McGowam & Junaina Muchammad, 2010.

[4] Essentials of Investments, Bodie, Zane; Alex Kane and Alan J. Marcus, 2004.

[5] Reviewing and Assessing financial information, techbooks, 2006.

[6] DuPont Analysis, Investopedia.com, 2011.

[7] Evaluating the impact of a rapidly changing economic environment on bank financial performance using the DuPont system of financial analysis, Henry W. Collier, Carl B. McGowam & Junaina Muchammad, 2010.

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A general definition of Systemic Risk which is not limited by its mathematical approaches, model assumptions or focus on one institution; and which is also the first operationalizable definition of Systemic Risk encompassing the systemic character of financial, political, environmental, and many other risks is available since 2010.[1]

The most recent empirical research on global Systemic Banking Crises (SBCs) has intensified the existence of similar patterns across diverse facts. SBCs are rare events. In the SBCs the recessions that follow are deeper and longer lasting than other recessions.[2]

SBCs follow credit intensive booms; “banking crises are credit booms gone wrong” (see e.g., Schularick and Taylor, 2012, p. 1032; the notion that banking crises are endogenous and follow prosperous times are also present in Minsky, 1977).

During the recent new financial crisis that started in 2007, and affect the hall world in 2008 the failure or impairment of a number of large, global financial institutions sent shocks through the financial system which, in turn, harmed the real economy. Supervisors and other relevant authorities had limited options to prevent problems affecting individual firms from spreading and thereby undermining financial stability. As a consequence, public sector intervention to restore financial stability during the crisis was necessary and conducted on a massive scale. Both the financial and economic costs of these interventions and the associated increase in moral hazard mean that additional measures need to be put in place to reduce the likelihood and severity of problems that emanate from the failure of global systemically important financial institutions (G-SIFIs).[3]

When a financial system is hit or threatened by widespread bank failures, as in Latin America, Scandinavia, Southeast Asia, or Japan in the 1990s, the cost of resolving the crisis and recapitalizing the banks can be enormous.[4]

The big global banks manage the savings of the people of the hall world, and thus are systemically important, meaning that they must have further supervision than other industry or commercial companies. The Financial Stability Board, (FSB) is one of the institutions in charge of making sure that these world systemic banks are safe. Even though there is a resistance from world systemic banks, the FSB, along with the BIS, are ordering them to increase the core tier 1 capital ratio (reflected to the CAD ratio) above the minimum defined by the Basel Committee (Basel III) to reflect their systemic significant, forcing world systemic banks to deal with higher costs of capital, but making sure that they are safer in the process.

1. World Systemic Banks

In November 2011 the Financial Stability Board published an integrated set of policy measures to address the systemic and moral hazard risks associated with systemically important financial institutions (SIFIs). In that publication, the FSB identified an initial group of G-SIFIs, namely 29 global systemically important banks (G-SIBs), using a methodology developed by the BCBS. The FSB and BCBS have updated the list of G-SIBs using end-2011 data to 28 banks. As noted in 2011, from this year, the list of G-SIBs shows their allocation to buckets corresponding to their required level of additional loss absorbency. Additional loss absorbency requirements for G-SIBs will be phased in starting from 2016, initially for those banks identified as G-SIBs in November 2014. The quality of data used in applying the identification methodology and to allocate G-SIBs into buckets for additional loss absorbency has improved considerably over the last year. In addition, several of the underlying data items included in the methodology have been refined to make the calibration more robust. The BCBS will continue to work to address remaining data quality issues and adopt any necessary methodological refinements before the loss absorbency requirements go into effect. The scores and the corresponding buckets for G-SIBs are provisional and will be based in the future on the best and most current available data prior to implementation. The group of G-SIBs will be updated in November 2013.[5]

The FSB, in consultation with IOSCO, will finalise a proposed assessment methodology for identifying systemically important non-bank non-insurance financial institutions over the course of 2013.

Too Big To Fail (TBTF): Is a traditional analysis for assessing the risk of required government intervention. The test (TBTF) can be measured in terms of an financial institution’s size relative to the national and international marketplace, market share concentration (using the Herfindahl-Hirschman Index for example), and competitive barriers to entry or how easily a financial product can be substituted.

The Basel Committee will group G-SIBs into different categories of systemic importance based on the score produced by the indicator-based measurement approach. GSIBs will be initially allocated into four buckets based on their scores of systemic importance, with varying levels of additional loss absorbency requirements applied to the different buckets as set out in section III.A.

In January 2011 the Basel Committee collected data for end-2009 which included the indicators of the indicator-based measurement approach from 73 banks. Sixteen of this sample of 73 banks was chosen from the world’s largest banks on the basis of size and supervisory judgment by Basel Committee member authorities. The Basel Committee then produced the trial score for all banks using the methodology described above.

Based on the results of applying the methodology, the Basel Committee is of the view that the number of G-SIBs will initially be 29, including two banks that have been added based on supervisory judgment applied by the home supervisor. A tentative cut-off point was set between the 27th and 28th banks, based on the clustering of scores produced by the methodology. It should be noted that this number would evolve over time as banks change their behavior in response to the incentives of the G-SIB framework as well as other aspects of Basel III and country specific regulations.

In deciding the threshold for the buckets, the Basel Committee considered several dimensions. One is that the buckets should be equal sized in terms of the scores. This will ensure the assessments of systemic importance are comparable across time and help to give banks incentives to reduce their systemic importance. In addition, thresholds for the buckets should broadly correspond to the gaps identified by a cluster analysis of the scores produced by the methodology. Another is the significance of cliff effects in the scoring. Based on the trial scores of the banks, the Basel Committee is of the view that four equal sized buckets between the cut-off score and the maximum score should be set. An empty bucket will be added on top of the highest populated bucket to provide incentives for banks to avoid becoming more systemically important. If the empty bucket becomes populated in the future, a new empty bucket will be added with a higher additional loss absorbency level applied.[6]

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[1] Market Dynamics & Systemic Risk by Milan Boran June 4, 2010 23rd Australasian Finance and Banking Conference 2010 Paper

[2]Booms and Systemic Banking Crises Frederic Boissay, Fabrice Collard and Frank Smets : Working Paper Series No 1514/february 2013

[3] Basel Committee on Banking Supervision Consultative Document Global systemically important banks: Assessment methodology and the additional loss absorbency requirement 7/2011

[4] Systemic Banking Crises by O. Emre Ergungor and James B. Thomson 2/2005

[5] Financial Stability Board 1/11/2012

[6] Basel Committee on Banking Supervision http://www.bis.org/publ/bcbs207.pdf

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Insurance is often easy to obtain against "systemic risks" because a party issuing that insurance can pocket the premiums, issue dividends to shareholders, enter insolvency proceedings if a catastrophic event ever takes place, and hide behind limited liability. Such insurance, however, is not effective for the insured entity.[1]

One argument that was used by financial institutions to obtain special advantages in bankruptcy for derivative contracts was a claim that the market is both critical and fragile.

Systemic risk can also be defined as the likelihood and degree of negative consequences to the larger body. With respect to federal financial regulation, the systemic risk of a financial institution is the likelihood and the degree that the institution's activities will negatively affect the larger economy such that unusual and extreme federal intervention would be required to ameliorate the effects.[2]

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[1] What Is Systemic Risk, and Do Bank Regulators Retard or Contribute to It? George G. Kaufman and Kenneth E. Scott The Independent Review, v. VII, n. 3, Winter 2003, ISSN 1086-1653, Copyright © 2003, pp. 371– 391.

[2] http://en.wikipedia.org/wiki/Systemic_risk

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Introduction

In finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to risk associated with any one individual entity, group or component of a system. It can be defined as "financial system instability, potentially catastrophic, caused or exacerbated by idiosyncratic events or conditions in financial intermediaries" It refers to the risks imposed by interlinkages and interdependencies in a system or market, where the failure of a single entity or cluster of entities can

cause a cascading failure, which could potentially bankrupt or bring down the entire system or market. It is also sometimes erroneously referred to as "systematic risk".

Systemic risk has been compared to a bank run which has a cascading effect on other banks which are owed money by the first bank in trouble, causing a cascading failure. As depositors sense the ripple effects of default, and liquidity concerns cascade through money markets, a panic can spread through a market, with a sudden flight to quality, creating many sellers but few buyers for illiquid assets. These interlinkages and the potential "clustering" of bank runs are the issues which policy makers consider when addressing the issue of protecting a system against systemic risk.[1]

Systemic risk should not be confused with market or price risk as the latter is specific to the item being bought or sold and the effects of market risk are isolated to the entities dealing in that specific item. This kind of risk can be mitigated by hedging an investment by entering into a mirror trade.[2]

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[1] Containing Systemic Risk, CRMPG III, August 6, 2008

[2] Banking and currency crises and systemic risk, George G. Kaufman (World Bank)