Designing an expert knowledge-based Systemic Importance Index for financial institutions

Carlos León and Clara Machado ()

Borradores de Economia from Banco de la Republica de Colombia

Abstract: Defining whether a financial institution is systemically important (or not) is challenging due to (i) the inevitability of combining complex importance criteria such as institutions’ size, connectedness and substitutability; (ii) the ambiguity of what an appropriate threshold for those criteria may be; and (iii) the involvement of expert knowledge as a key input for combining those criteria. The proposed method, a Fuzzy Logic Inference System, uses four key systemic importance indicators that capture institutions’ size, connectedness and substitutability, and a convenient deconstruction of expert knowledge to obtain a Systemic Importance Index. This method allows for combining dissimilar concepts in a non-linear, consistent and intuitive manner, whilst considering them as continuous –non binary- functions. Results reveal that the method imitates the way experts them-selves think about the decision process regarding what a systemically important financial institution is within the financial system under analysis. The Index is a comprehensive relative assessment of each financial institution’s systemic importance. It may serve financial authorities as a quantitative tool for focusing their attention and resources where the severity resulting from an institution failing or near-failing is estimated to be the greatest. It may also serve for enhanced policy-making (e.g. prudential regulation, oversight and supervision) and decision-making (e.g. resolving, restructuring or providing emergency liquidity).

Keywords: Systemic Importance; Systemic Risk; Fuzzy Logic; Approximate Reasoning; Too-connected-to-fail; Too-big-to-fail. (search for similar items in EconPapers)
JEL-codes: C63 D85 E58 G28 (search for similar items in EconPapers)
Date: 2011-08
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Citations: View citations in EconPapers (5)

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Working Paper: Designing an expert knowledge-based Systemic Importance Index for financial institutions (2011)
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Persistent link: https://EconPapers.repec.org/RePEc:bdr:borrec:669

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