Systemic Importance Index for financial institutions: A Principal Component Analysis approach

Carlos Eduardo Le�n and Andrés Murcia
Authors registered in the RePEc Author Service: Carlos León

No 10067, Borradores de Economia from Banco de la Republica

Abstract: As a result of the most recent global financial crisis literature has embraced size, connectedness and substitutability as key indicators for financial institutions� systemic importance. Despite the intuitiveness of these concepts, identifying systemic important institutions remain a non-trivial task that implies two primary challenges. First, designing metrics for connectedness and substitutability may require, as acknowledged by literature, non-standard data sources and techniques. Second, choosing a methodology capable of aggregating the metrics designed for the three aforementioned concepts into a systemic importance index may be intricate. The herein paper addresses the second challenge. The chosen approach is to apply Principal Components Analysis to the metrics designed by Le�n and Machado (2011) for assessing size, connectedness and substitutability, where those metrics rely on a combination of balance sheet data and the application of network theory to large-value payment system�s information.Results (i) demonstrate that the three concepts and their metrics are explanatory and non-redundant for differentiating financial institutions� relative systemic importance; (ii) allow for constructing a PCA-based Systemic Importance Index, a valuable tool for financial authorities� policy and decision-making; and (iii) confirm the importance of the too-connected-to-fail criteria and the presence of non-banking firms among the most systemically important financial institutions in the Colombian case.

Keywords: Systemic Importance; Systemic Risk; Principal Components Analysis; Too-connected-to-fail; Too-big-to (search for similar items in EconPapers)
JEL-codes: C63 D85 E58 G28 (search for similar items in EconPapers)
Pages: 31
Date: 2012-10-21
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Citations: View citations in EconPapers (12)

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Working Paper: Systemic Importance Index for financial institutions: A Principal Component Analysis approach (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:col:000094:010067

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