Applying the most commonly cited definition of systemic risk, that of the Financial Stability Board (FSB), to the core activities of insurers and reinsurers, the report concludes
that none are systemically relevant for at least one of the following reasons: • Their limited size means that there would not be disruptive effects on financial markets; • An insurance insolvency develops slowly and can often be absorbed
by, for example, capital raising, or, in a worst case, an orderly wind down; • The features of the interrelationships of insurance activities mean that contagion risk would be limited.
Though each individual model may be made accurate, the facts that (1) all models across the board use the same theoretical basis, and (2) the relationship between financial
markets and the economy is not known lead to aggravation of systemic risks.
 Manzo and Picca introduce the t-Student Distress Insurance Premium (tDIP), a copula-based method that measures systemic risk as the expected tail loss on a credit
portfolio of entities, in order to quantify sovereign as well as financial systemic risk in Europe.
For most classes of insurance, however, there is little evidence of insurance either generating or amplifying systemic risk, within the financial system itself or in the real
In February 2020 the European Systemic Risk Board warned in a report that substantial amounts of financial instruments with complex features and limited liquidity that sit
in banks’ balance sheets are a source of risk for the stability of the global financial system.
 A key conclusion of the analysis is that the core activities of insurers and reinsurers do not pose systemic risks due to the specific features of the industry: • Insurance
is funded by up-front premia, giving insurers strong operating cash-flow without the requirement for wholesale funding; • Insurance policies are generally long-term, with controlled outflows, enabling insurers to act as stabilisers to the
financial system; • During the hard test of the financial crisis, insurers maintained relatively steady capacity, business volumes and prices.
 It takes an “operational behaviour” approach to defining systemic risk of failure as: “A measure of the overall probability at a current time of the system entering an
operational state of systemic failure by a specified time in the future, in which the supply of financial services no longer satisfies demand according to regulatory criteria, qualified by a measure of uncertainty about the system’s future
behaviour, in the absence of new mitigation efforts.”
In finance, systemic risk is the risk of collapse of an entire financial system or entire market, as opposed to the risk associated with any one individual entity, group or
component of a system, that can be contained therein without harming the entire system.
TCTF is a measure of the likelihood and amount of medium-term net negative impact to the larger economy of an institution’s failure to be able to conduct its ongoing business.
 Banks are the entities most likely to be exposed to valuation risk as a result of their massive holdings of financial instruments classified as Level 2 or
3 of the fair value hierarchy.
While financially interconnected systems with debt and equity cross-ownership without derivatives are fairly well understood in the sense that relatively weak conditions on
the ownership structures in the form of ownership matrices are required to warrant uniquely determined price equilibria, the Fischer (2014) model needs very strong conditions on derivatives – which are defined in dependence on
any other liability of the considered financial system – to be able to guarantee uniquely determined prices of all system-endogenous liabilities.
 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, was put forth in 2010.
 At present, it is unclear how weak conditions on derivatives can be chosen to still be able to apply risk-neutral pricing in financial networks with systemic risk.
Second, the TCTF test is a measure of the likelihood and amount of medium-term net negative impact to the larger economy of an institution’s failure to be able to conduct
its ongoing business.
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.
Thus the systemic risk migrated from one sector to another and proves that regulation of only one industry cannot be the sole protection against systemic risks.
 express concerns about systemic risk measurements, such as SRISK and CoVaR, because they are based on market outcomes that happen multiple times a year, so that the
probability of systemic risk as measured does not correspond to the actual systemic risk in the financial system.
 An excessive number of market operators was sometimes deliberately introduced with a below market value selling to cause a price war and a wave of bank massive
failures, subsequently degenerating in the creation a market cartel: those two phases had been seen as expressions of the same interest to collude at generally lower prices (and then higher), resulting possible because of a lack of regulation
ordered to prevent both of them.
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.
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.
PMI PMBOK(R) Guide defines individual project risk as “an uncertain event or condition that, if it occurs, has a positive or negative effect on one or more project objectives,”
whereas overall project risk is defined as “the effect of uncertainty on the project as a whole … more than the sum of individual risks within a project, since it includes all sources of project uncertainty … represents the exposure of stakeholders
to the implications of variations in project outcome, both positive and negative.
 Acemoglu, Ozdaglar, and Tahbaz-Salehi, (2015) developed a structural systemic risk model incorporating both distress costs and debt claim with varying priorities and
used this model to examine the effects of network interconnectedness on financial stability.
• Strengthening liquidity risk management, particularly to address potential mis-management issues related to short-term funding.
The Merton (1974) model Situations as the one explained earlier, which are present in mature financial markets, cannot be modelled within the single-firm Merton model,
but also not by its straightforward extensions to multiple firms with potentially correlated assets.
The report therefore identifies two activities which, when conducted on a widespread scale without proper risk control frameworks, have the potential for systemic relevance.
A key conclusion of the statement was that, “The insurance sector is susceptible to systemic risks generated in other parts of the financial sector.
 As an implication, even small errors in such financial instruments’ valuations may have significant impacts on banks’ capital.
 As an implication, even small errors in such financial instruments’ valuations may have significant impacts on banks’ capital.
 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.
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
For example, the banking sector was brought under regulations in order to reduce systemic risks.
Nevertheless, some recent work has started to challenge this view, investigating conditions under which diversification may have ambiguous effects on systemic risk.
 The need for proper structural models of financial interconnectedness in quantitative risk management – be it in research or practice – is therefore obvious.
Participants in the market, like hedge funds, can be the source of an increase in systemic risk and the transfer of risk to them may, paradoxically, increase the exposure
to systemic risk.
 On the other hand, the same effect was measured in presence of a banking oligopoly in which banking sector was dominated by a restricted number of market
operators encouraged by their market share and contractual power to set higher loan mean rates.
Measurement TBTF/TCTF According to the Property Casualty Insurers Association of America, there are two key assessments for measuring systemic risk, the “too big to
fail” (TBTF) and the “too (inter)connected to fail” (TCTF or TICTF) tests.
“System-exogenous” here refers to the assumption, that the business asset is not influenced by the firms in the considered financial system.
 Since the banks themselves could not give credit where the risk (and therefore returns) were high, it was primarily the insurance sector which took over such deals.
 Project risks In the fields of project management and cost engineering, systemic risks include those risks that are not unique to a particular project and are not readily
manageable by a project team at a given point in time.
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.
Systematic risk, also called market risk or un-diversifiable risk, is a risk of a security that cannot be reduced through diversification.
The industry has put forward five recommendations to address these particular activities and strengthen financial stability: • The implementation of a comprehensive, integrated
and principle-based supervision framework for insurance groups, in order to capture, among other things, any non-insurance activities such as excessive derivative activities.
Until recently, many theoretical models of finance pointed towards the stabilizing effects of a diversified (i.e., dense) financial system.
By accounting for different factors, one captures the notion that shocks to the US or Asian markets may affect Europe, but also that bad news within Europe (such as the news
about a potential default of one of the countries) matters for Europe.
 In contrast, those risks that are unique to a particular project are called overall project risks aka systematic risks in finance terminology.
 In the report, the differing roles of insurers and banks in the global financial system and their impact on the crisis are examined (See also CEA report, “Why Insurers
Differ from Banks”).
However, during the financial crisis, a small number of quasi-banking activities conducted by insurers either caused failure or triggered significant difficulties.
In contrast to most of the structural systemic risk literature, their results are quite general and do not require assuming a specific network architecture or specific shock
 A series of empirical studies published between the 1990s and 2000s showed that deregulation and increasingly fierce competition lowers bank’s profit margin and encourages
the moral hazard to take excessive credit risks to increase profits.
 Governments and market monitoring institutions (such as the U.S. Securities and Exchange Commission (SEC), and central banks) often try to put policies and rules in
place with the justification of safeguarding the interests of the market as a whole, claiming that the trading participants in financial markets are entangled in a web of dependencies arising from their interlinkage.
 To demonstrate this, consider two financial firms, , with limited liability, which both own system-exogenous assets of a value at a maturity , and which both owe a single
amount of zero coupon debt , due at time .
These risks may be driven by the nature of a company’s project system (e.g., funding projects before the scope is defined), capabilities, or culture.
The impact is measure beyond the institution’s products and activities to include the economic multiplier of all other commercial activities dependent specifically on that
Of these, €6.6 trillion were classified as Level 2 or 3 in the so-called Fair Value Hierarchy, which means that they are potentially exposed to valuation risk, i.e.
They are project-specific risks which are sometimes called contingent risks, or risk events.
Systemic financial crises happen once every 43 years for a typical OECD country and measurements of systemic risk should target that probability.
Policy makers frequently claim that they are concerned about protecting the resiliency of the system, rather than any one individual in that system.
The report underlines that supervisors and policymakers should focus on activities rather than financial institutions when introducing new regulation and that upcoming insurance
regulatory regimes, such as Solvency II in the European Union, already adequately address insurance activities.
 Too big to fail Main article: Too big to fail The traditional analysis for assessing the risk of required government intervention is the “too big to fail” test
TBTF can be measured in terms of an 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 product can be substituted.
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Photo credit: https://www.flickr.com/photos/ell-r-brown/5970868068/’]