Selody, Jack --- "The Nature of Systemic Risk" [2011] ELECD 487; in LaBrosse, Raymond John; Olivares-Caminal, Rodrigo; Singh, Dalvinder (eds), "Managing Risk in the Financial System" (Edward Elgar Publishing, 2011)

Book Title: Managing Risk in the Financial System

Editor(s): LaBrosse, Raymond John; Olivares-Caminal, Rodrigo; Singh, Dalvinder

Publisher: Edward Elgar Publishing

ISBN (hard cover): 9780857933812

Section: Chapter 2

Section Title: The Nature of Systemic Risk

Author(s): Selody, Jack

Number of pages: 13

Extract:

2. The nature of systemic risk
Jack Selody1

2.1. INTRODUCTION

The fragility of the world financial system after the 2007 meltdown of
the US subprime securities market was surprising. Policymakers had
been working diligently in the years prior to the shock to strengthen the
robustness of the infrastructure connecting major elements of the system.
Many national large value payment systems had been risk proofed.2 The
Continuous Linked Settlement (CLS) bank had recently launched, which
risk proofed large value foreign exchange transactions in major curren-
cies.3 Bank deposit insurance was widespread and deposit-taking institu-
tions were heavily regulated.4 Based on previous crisis experience this risk
proofing should have made the world financial system robust even to large
shocks and prevented it from going into crisis. Indeed, the newly risk-
proofed elements held up well during the crisis.
The episode reminds us that modern financial systems are complex and
not well understood. Not surprisingly, the crisis triggered an impetus for
regulatory reform that ranges from proposals to strengthen existing con-
trols to calls for a paradigm shift. At issue is how best to protect against
systemic risk. Achieving this objective requires a good understanding of
the nature of that risk.
In this chapter I look beyond the details of the recent crisis to ask: what
constitutes the nucleus of a modern financial system and what makes it
vulnerable to failure? I argue that the nucleus is the cluster of financial
markets and supporting infrastructure that coordinates the ...