What is the Minimal Systemic Risk in Financial Exposure Networks? INET Oxford Working Paper, 2019-03

Christian Diem, Anton Pichler, Stefan Thurner

Publikation: Working/Discussion PaperWorking Paper/Preprint

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Management of systemic risk in financial markets is traditionally associated with setting (higher) capital
requirements for market participants. There are indications that while equity ratios have been increased
massively since the financial crisis, systemic risk levels might not have lowered, but even increased (see
ECB data
; SRISK time series
). It has been shown that systemic risk is to a large extent related to the
underlying network topology of financial exposures. A natural question arising is how much systemic risk
can be eliminated by optimally rearranging these networks and without increasing capital requirements.
Overlapping portfolios with minimized systemic risk which provide the same market functionality as empir-
ical ones have been studied by Pichler et al. (2018). Here we propose a similar method for direct exposure
networks, and apply it to cross-sectional interbank loan networks, consisting of 10 quarterly observations
of the Austrian interbank market. We show that the suggested framework rearranges the network topol-
ogy, such that systemic risk is reduced by a factor of approximately 3.5, and leaves the relevant economic
features of the optimized network and its agents unchanged. The presented optimization procedure is not
intended to actually re-configure interbank markets, but to demonstrate the huge potential for systemic
risk management through rearranging exposure networks, in contrast to increasing capital requirements
that were shown to have only marginal effects on systemic risk (Poledna et al., 2017). Ways to actually
incentivize a self-organized formation toward optimal network configurations were introduced in Thurner
and Poledna (2013) and Poledna and Thurner (2016). For regulatory policies concerning financial market
stability the knowledge of minimal systemic risk for a given economic environment can serve as a benchmark
for monitoring actual systemic risk in markets.
PublikationsstatusVeröffentlicht - 2019