October 10, 2017

Mr. Hyun Song Shin, Economic Adviser and Head of Research of the BIS, spoke at the IMF conference on Systemic Risk and Macro-prudential Stress Testing in Washington DC. He discussed “leverage in the small and in the large,” wherein leverage in the small refers to the leverage of individual institutions while leverage in the large refers to the leverage of the financial system as a whole.

As per Mr. Shin, these two notions of leverage correspond to two directions in gauging systemic risk. One is to drill down to detailed micro evidence of how financial institutions are intertwined and delve into the complex web of interconnections. The other direction is to "drill up," to the macro, and indeed global, aggregates. Of the two, drilling up is often more informative, as it delivers the all-important time dimension of systemic risk—how it builds up over time and how it unwinds.

He argues for two propositions. “First, mitigating complexity is mostly about taming leverage in the small. The motto is: if you take care of leverage in the small, complexity will take care of itself. Second, lest we fall into complacency, taming complexity is not enough to ward off systemic risk. Systemic risk is mostly about leverage in the large. Addressing systemic risk entails taking a macro and global perspective. Here, the motto is: take a global approach to macro-prudential frameworks.”

 

Related Link: Speech (PDF)

Keywords: International, Banking, Systemic Risk, Leverage, Macro-prudential Framework, BIS

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