Firms» risk management practices Supervisory responses

9 Network analysis DIRECTION DE LA STABILITE FINANCIERE 10 Network analysis DIRECTION DE LA STABILITE FINANCIERE The regulator will be able to compute such measures of systemic risk impact if institutions are required to disclose, not only an aggregate risk figure such as VaR, but also their risk exposures above a given threshold to all counterparties. This will enable the regulator to map the counterparty network Co-risk Analysis Capturefinancial institutions» co-dependence risk arising from direct and indirect linkages from publicly available data. Indirect linkages arise from exposure to common risk factors such as reliance on wholesale funding markets, similar portfolios, and so on. Thus, this work can complement network analysis. Under efficient markets, pricing of indirect linkages should result in co-move- ments of institutions» equity prices and credit risk measures, such as CDS spreads, Moody»s KMV Expected Default Frequencies, Bond Spreads. Nodes are scaled by Total External Assets + Total External Liabilities for each node, and links between nodes i and j by Total External Assetsij + Total External Liabilitiesij GDPi+ GDPj . The data are developed and analyzed in Kubulec and Sa 2008. 11 There are other modelsº DIRECTION DE LA STABILITE FINANCIERE 12 Summary of various methodologies1 DIRECTION DE LA STABILITE FINANCIERE 1 3 Chan-Lau, Espinosa and Solé 2009 2 Giesecke and Kim 2009 4 Segoviano Goodhart 2009 WeaknessesConditions When Measure May Be Misleading Network Simulations 1 Default Intensity Model 2 Co-Risk Analysis 3 Time-Varying Multivariate Density, Distress Dependence, and Tail Risk 4 Policy Implications Does not incorporate institution» endogenous response to distress events. Data limitations may include lack of off-balance-sheet exposure information. Reduce form model. Usefulness is undermined by factors that affect market efficiency. CDS may overstate objective default probabilities. Help policymakers identify 1 institutions whose failure might trigger domino effects; and 2 institutions most vulnerable to shocks stemming from other institutions» failure. Allows elaboration of potential contagion paths following financial distress events. Inform policymakers abaout the likelihood of tail event arising from both direct and indirect financial linkages. Provide policymakers with information to identify not only how common risk are evolving, but where spillovers might most easily develop and how distress in specific institution can affect other institution. Provide policymakers with information to identify not only how common risk are evolving, but where spillovers might most easily develop and how distress in specific institution can affect other institution. Source: IMF staff. 13

2. Supervisory responses

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2. Supervisory responses

DIRECTION DE LA STABILITE FINANCIERE Systemic risk management - some academic proposals - Best positioned to monitor systemic risk = Central banks - Should that body be independent or not? - On going discussion across jurisdictions to set up institutions to perform this duty with possible different approach : US approach vs. EU approach ; - The setting up of the European Systemic Risk Council - Furthermore, in an integrated financial system, judgments have to be made on a worldwide basis. Kashyap et al Kashyap et al Kashyap et al Kashyap et al Kashyap et al Asharya et al Asharya et al Asharya et al Asharya et al Asharya et al Perotti-Suarez Perotti-Suarez Perotti-Suarez Perotti-Suarez Perotti-Suarez Nature of the Bank capital Regulated institutions» capital Liquidity possiblycapital insurance for institutions have access to public guarantee schemes Participation Optional Mandatory Mandatory Insurer Private Public + private International liquidity insurance fund Price calculation To be determined by the Market measure of the systemic A proportion of short institution risk of the institution term marketable debt Trigger for Cumulative losses over the Cumulative losses in the financial Aggregate liquidity squeeze compensation preceding 4 quarters excee system or the national economy in the interbank market, to be ding a predefined amount exceeding a predefined determined by supervisors amount set by regulators Compensation A share of the aggregate system Help meet the target of 8 Undefined amount losses in a range of 100-200 Bn solvency ratio USD, when losses exceed that level, the amount is capped Institutional challenges 15

2. Supervisory responses : risk mitigation

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2. Supervisory responses : more details in

DIRECTION DE LA STABILITE FINANCIERE Combining the two components of macrosupervision systemic and macroeconomic with the two approaches automatic and discretionary produces an interesting classification, which is presented in the table below : Source : Banque de France, JP Landau Thank you Mechanisms Purpose Systemic risk Adjustment to macroconditions Automatic Automatic Automatic Automatic Automatic Discretionary Discretionary Discretionary Discretionary Discretionary buffers capital andor liquidity Loan to Value ratios accounting framework stress test pillar II of Basel 2 time varying capital ratios dynamic provisioning discretionary adjustment to capital ratios, provisions or margin requirements This page is intentionally left blank