Risque systémique

Financial risk in the banking system

1. Introduction

Risk is a potential barrier to achieving an objective. It is an inherent component of human life. Indeed, when a doctor takes care of a patient whose disease he does not yet know, he takes risks of contamination. When you cross a road without looking left and then right, you take risks. Or in a financial system, random events can be considered as risks. All these examples show us various types of risks, but the one that will interest us the most will be financial risk, more particularly systemic risk. During our essay, we will explain it and see if there are any measures that can be taken to prevent it from being carried out, or so that once it is already in place, we can find solutions to overcome it.

1. Development

Systemic risk by definition affects not only a financial institution, but the economy as a whole. To make it simple, we can use an analogy. Indeed, let's suppose that my body is a system so cancer is a systemic risk for me. It causes a chain of events that can lead to organ failure and death. Or when a company is a system, bankruptcy becomes its cancer. In this sense, it can be argued that the failure of Lehman Brother was a systemic risk because it was also the cause of a severe liquidity crisis that almost brought the global financial system to its knees. It officially went bankrupt on 15 September 2008 following the global financial crisis that emerged in the wake of the subprime crisis. Two years of investigation by the judicial expert Anton Valukas into the accounts of Lehman Brothers have resulted in a 2200-page report that is overwhelming. The bank's management is accused of having been involved in large-scale accounting manipulations in order to conceal losses. Lone and behold, Lehman Brother used an accounting manoeuvre called "Repo 105" that allowed them to hide the balance sheet, in particular by reducing debt ratios and improving liquidity levels.

 Indeed, it lent rotten assets to banks in the Cayman Islands in exchange for liquidity but noted in its balance sheet that these transactions were sales and not borrowings.

In addition, this example can show us the importance of avoiding systemic risks and there are ways to do this. Indeed, a public intervention that would first be preventive could be put in place. Banking activity and the functioning of financial markets are governed by rules, control and supervision mechanisms set up by public authorities to prevent the occurrence of systemic shocks or events. It is a question of preventing actors from taking too many risks and behaving badly. For example, financial institutions must hold a minimum amount of equity capital that depends on the degree of risk of their assets. They are required to provide the public authorities with very extensive information on the risks they incur and the quality of their asset portfolios. On the other hand, the hands of governments should be untied so that they are no longer forced to systematically bail out the major systemic banks. The idea would be to split these two financial pillars, on the one hand there would be the bank in the social sector, which makes loans to companies, especially SMEs and households, and which collects and manages deposits and on the other, capital markets banking. Only the commercial banking part would benefit from the protection of the State and would therefore bind the taxpayer.