Systemic risk in banking and insurance with practical application to South African financial institutions

Abstract

In the highly interconnected financial sector, systemic risk represents a persistent concern for policymakers and the regulators of financial-sector entities. This research aims to enhance in practical ways the understanding of the nature of systemic risk in South Africa’s banking and insurance markets. Five interlinked studies are presented, each a chapter of this thesis. Utilising both quantitative and qualitative methods, these studies aim to provide a range of insights to assist regulators to identify the sources of systemic risk and to mitigate the impacts of this risk more effectively.

Several findings may prove helpful, starting with those that apply to banks. Considering first the entities themselves, South Africa’s largest banks appear to contribute disproportionately to levels of systemic risk. For some of them, the tail correlation of extreme events at individual banks and the market as a whole appears also to be greatest. Turning next to attributes of the banking system as a whole, analysis of the indicator of the level of systemic risk suggests a tipping point in its sensitivity to changes in the assumed extent to which a shock to one bank impacts the values of assets at other banks. In other words, while specific entities may contribute disproportionately to systemic risk, under certain conditions a small change to a single assumption could have substantial adverse impacts on system stability.

The research also considers the potential for systemic risk arising in insurers. A comprehensive review of the literature concludes that systemic risk arising in South African insurers is a realistic probability. A framework is proposed for classifying and hence identifying the risks that may be systemic in nature, using published information from South African insurers to show how the framework may be utilised in practice.

Each chapter provides a review of the relevant literature, describes the research approach and its findings, expresses the implications of these findings in practical ways and proposes further possibilities for enquiry. The emphasis throughout this work is on the application of the findings to a more effective regulatory system. Enhanced effectiveness benefits not only the customers of these banks and insurers but all who live in this country and are impacted by systemic insecurity.