Extreme Events in Finance

Chapter 13Comparing Tail Risk and Systemic Risk Profiles for Different Types of U.S. Financial Institutions

Stefan Straetmans and Thanh Thi Huyen Dinh

School of Business and Economics, Maastricht University, Maastricht, The Netherlands

JEL codes: G21, G28, G29, G12, C49.

13.1 Introduction

The Basel II framework identifies credit risk, market risk, and operational risk as the key risk factors for financial institutions. Prior to the Crisis, the dominant opinion used to be that by appropriately managing these risks, financial institutions can maximize the probability of their continued survival while delivering appropriate profit to the capital providers. However, this financial regulatory framework is essentially micro-prudential in nature in the sense that it is designed to limit each institution's risk individually. However, Basel II typically did not take into account that distressed systemically important companies can destabilize the whole financial system as well as causing negative effects on real economic activity. The recent financial crisis created a conscience that there is an urgent need to complement Basel II with regulations that also take into account these macro-prudential concerns, that is, the need to monitor the so-called systemic risk. Thus, in order to preserve monetary and financial stability, central banks, as well as regulatory and supervisory authorities (often one and the same entity), ideally should have a regulatory and supervisory framework that ...