Financial system risk
Puzzling as it may be, underlying causes of any a financial crisis can be arrested and prevented if the right information and action is taken at the right time. This is also true with any financial system risk. A financial system is defined by processes and procedures used by a firm’s management to exercise financial control and accountability. These measures include recording, verification, and timely reporting of transactions that affect revenues, expenditures, assets, and liabilities (defined in the Business Directory).
Variety of financial analysts draw facts and analytical number figures derived from the world corporate financial market trends to create the framework designed to create systems for regulating the financial system risk for individual financial institutions as well as the financial industry as a whole. With the broadening capital market funding, there is a great shift from the traditional definition of financial system risk as mainly relating to banks as the financial institutions.
Increasing disintermediation, and “given the interconnectedness of the modern financial sector, and for the purposes of systemic regulation, one should think of a “financial firm” as not just the commercial bank taking deposits and making loans, but also include investment banks, money market funds, insurance firms, and potentially even hedge funds and private equity funds” (Acharya et al. , 2008).
Regulation of financial system risk poses challenges in its measurement as much as it poses in basing the stringency of the regulation that would outline how each firm would be charged with the responsibility of absorbing their system risk based on the effect their system risk would have on the overall crisis. In any financial industry, underlying regulations are implemented to cushion any company or the economy from the failure of one or most of the components of the world economy. This reassures non-occurrence of cyclical deterioration of the economy in a given country or the world over.
In order to clearly comprehend the extent of the effects of the financial system risk, many analysts and authors have not only authored facts and implications, but unveiled carefully drafted system risk regulations. However, not all analysts and system risk researchers have come to a common conclusion on what system risk is, the underlying causes and effects on the economy and impact in the current crisis. Current financial system risk evaluation methodologies have posed challenges on pointing its implication on financial crises.
Cyclical occurrences of economical crisis may be an indication of an unforeseen gap in the definition and prevention of the impact of the system risk on the economic crisis. By treating financial system risk as a fundamental contributor to financial risk, we provide core sets of tools of evaluation that would point the source of risk. This approach would significantly enhance traceability of system risk and provide factual information on how to adequately regulate financial institutions to lower their system risk. The desirable end result is the assurance of financial stability in the global setting.
WHY ANALYZE FINANCIAL SYSTEM RISK Adequate presentation of the core cause of financial system risk forms the route map to sufficient levels of regulation that annul the risk shock on the economy. Detrimental frameworks come to play on the economic setup when adequate regulation lacks. Disintegration of the economy’s foundation then shows the results of a failing system risk regulatory framework. Regulators are tasked with the duty of ensuring that this outcome does not represent the reality of the given economical situation.
Successfully operational economic machinery is the goal of regulators and analysts who seek to break and build the financial wall around the economy to sustain financial stability. The mission and vision of the world economy builders is to have the financial stability that would sustain growth and development the world over. In order to make this a reality, elementary studies must be carried out to unveil the foundation of the economy, the stability of the economy builders, and their awareness of the risk of ignoring the reality of the impact financial failure would have on them and on the cyclic financial system.
Financial system risk analysis then becomes the primary focus to ensure financial forecast is done to curtail the outcome of a financial crisis. When adequate system risk analysis and regulation is not achieved, the economic shock is indicative of the current crisis. The nucleus of analysis is the knowledge of how to weigh the symptoms of system risk and provide adequate regulatory guide lines. In their article, “The Credibility Problem”, Adam Lerrick and Allan H.
Meltzer (2002: 1) assert that, The impoverishment caused by broken promises on the part of governments that fail to protect private property rights, enforce contracts, and limit taxing and spending to prudent levels is evident in the increased frequency of financial crises in emerging market economics. Argentina’s stunning default in December 2001 and the Brazilian crisis in 2002 are only the latest examples of how bad government policies undermine confidence and destroy wealth.
The International Monetary Fund’s refusal to bail out Argentina was an admission that a new course was needed to deal with sovereign debt crises, which are closely linked with currency and banking crises (p. 1) MEASUREMENT OF SYSTEM RISK Economic crisis and collapse can be aggregated in every financial institutions systemic risk and contribution to the economic upset. Projection of a firms risk probability helps underline the firm’s possible level of contribution to the general economic collapse.
Economic collapse and the current crisis can be traced back to the start points of financial firms’ inadequately regulated systemic risk. However, systemic risk cannot be adequately regulated without comprehensively measuring the underlying causes and impact of financial deterioration. Aggregate economic collapse could be proxied by a severe fall in aggregate economy’s output (for example, negative GDP growth rates) or stock market crashes (assuming that these precede real sector losses) or banking sector’s profitability.
A financial firm that contributes a lot to such aggregate economic risk poses systemic risk (Acharya et al. , 2008). Increasing globalization and complexity in the financial system lead to reduction in independence of financial firms, increases interconnectivity and challenges in system risk regulation. On the other hand, management of system risk and timely policy response is hampered by the lack of control of the increasing tightness in the interconnectivity of financial service providers.