The structural fragility of financial systems: Analysis and modeling implications for early warning systems

Abstract

Purpose

Lessons from the most recent financial crisis show specific vulnerabilities of financial markets due to weaknesses in the structure of the financial system (structural fragility). As the literature points out, the impact of systemic risk can be closely related to issues of concentration (“too big to fail”) and dependency (“too connected to fail”). However, different structural variables are emphasized in various ways, and most authors analyze each variable separately. This raises the questions of how structural fragility, as a cause of systemic distress, can be assessed more comprehensively and consistently, and what the implications are for modeling it within an integrated systemic risk framework. This paper seeks to address these issues.

Design/methodology/approach

On the basis of theoretical considerations and in the light of current transformations in financial markets, this paper explores elements of structural fragility and the requirements for modeling them.

Findings

The paper suggests an extended approach for conceptualizing structural fragility, evaluates directions for quantifying structural issues in early warning systems (EWSs) for systemic crises, and lays a theoretical groundwork for further empirical studies.

Originality/value

The need for supervisory actions to prevent crises is urgent, as is the need for integrating structural aspects into EWSs for systemic financial crises. Since a significant aspect of a financial firm's risk comes from outside the firm, individual institutions should understand and monitor the structural aspects of the various risk networks they are in.

Citation

Gramlich, D. and Oet, M.V. (2011), "The structural fragility of financial systems: Analysis and modeling implications for early warning systems", Journal of Risk Finance, Vol. 12 No. 4, pp. 270-290. https://doi.org/10.1108/15265941111158460