Systemic Risk in Financial Institutions of BRICS: Measurement and Identification of
Firm-Specific Determinants
Authors: Shumaila Zeb & Abdul Rashid
Published in: Risk Management (Springer Nature, 2019)
1. INTRODUCTION
The financial system consists of banks, financial service firms, and insurance companies. These
institutions are interconnected with each other. Due to this interconnectedness, problems arising
in one institution can spread rapidly throughout the entire financial system. This phenomenon is
known as contagion.
When adverse shocks spread from one institution to many others and threaten the stability of the
entire financial system, the resulting threat is called systemic risk. Systemic risk can generate
severe economic consequences, including financial crises, banking failures, economic recessions,
and instability in capital markets.
The global financial crisis highlighted the importance of understanding systemic risk and
identifying institutions that contribute significantly to financial instability.
Most previous studies focused on developed countries such as the United States and European
economies. Little evidence existed regarding systemic risk in emerging economies, especially
BRICS nations. Therefore, this study attempts to fill this gap.
2. WHY BRICS COUNTRIES WERE CHOSEN?
BRICS consists of:
Brazil
Russia
India
China
South Africa
These countries are among the largest emerging economies in the world and are becoming
increasingly interconnected financially and economically.
The BRICS alliance aims to:
Increase economic cooperation
Improve financial stability
Enhance regional integration
Reduce dependence on developed economies
Because financial institutions in BRICS countries are becoming increasingly connected,
understanding the sources of systemic risk becomes crucial for maintaining financial stability.
3. OBJECTIVES OF THE STUDY
The study has two major objectives:
Objective 1
Measure the systemic risk contribution of:
Banks
Financial service firms
Insurance companies
in each BRICS country.
Objective 2
Identify firm-specific factors that influence systemic risk in these institutions.
The findings are expected to help policymakers and regulators develop effective regulations to
reduce systemic risk and improve financial stability.
4. DATA USED IN THE STUDY
Time Period
2000–2015
Data Source
Thomson Reuters Financial DataStream
The database provided:
Stock prices
Risk factors
Financial statements
Firm characteristics
of financial institutions.
5. SAMPLE OF THE STUDY
The study uses an unbalanced panel dataset of approximately 300–330 financial institutions
across BRICS countries.
Brazil
34 Banks
29 Financial Service Firms
10 Insurance Companies
Total = 73 institutions
Russia
5 Banks
4 Financial Service Firms
Insurance companies excluded due to lack of data.
Total = 9 institutions
India
41 Banks
12 Financial Service Firms
76 Insurance Firms
Total = 128 institutions
China
12 Banks
17 Financial Service Firms
4 Insurance Firms
Total = 33 institutions
South Africa
12 Banks
15 Financial Service Firms
31 Insurance Firms
Total = 58 institutions
6. WHAT IS SYSTEMIC RISK?
Systemic risk refers to the risk that the failure of one institution may trigger failures throughout
the financial system.
Unlike individual risk, systemic risk affects:
Multiple institutions
Financial markets
The economy as a whole
For example:
If a large bank collapses, its inability to repay obligations can create losses for many other
institutions connected to it. This chain reaction can threaten the entire financial system.
7. METHODOLOGY USED TO MEASURE SYSTEMIC RISK
The authors use:
ΔCoVaR (Delta Conditional Value at Risk)
developed by Adrian and Brunnermeier (2016).
8. UNDERSTANDING VaR
Value-at-Risk (VaR)
VaR measures the maximum expected loss of an institution over a specified period at a given
confidence level.
Example:
If a bank's VaR is $100 million at 99% confidence level, there is only a 1% chance that losses
will exceed $100 million.
VaR measures individual institution risk.
9. UNDERSTANDING CoVaR
Conditional Value-at-Risk (CoVaR)
CoVaR measures the risk of the financial system conditional on a specific institution being under
stress.
It answers:
"What happens to the whole financial system when a particular institution experiences distress?"
CoVaR therefore captures risk spillovers.
10. UNDERSTANDING ΔCoVaR
ΔCoVaR measures the difference between:
System risk when a firm is under distress (1% worst condition)
System risk when a firm is in normal condition (50% median state)
ΔCoVaR=CoVaRDistress−CoVaRNormal\Delta CoVaR = CoVaR_{Distress} -
CoVaR_{Normal}ΔCoVaR=CoVaRDistress−CoVaRNormal
A larger absolute ΔCoVaR means:
Greater contribution to systemic risk
Greater danger to the financial system
Financial institutions with larger absolute ΔCoVaR values are considered more systemically
important.
11. RISK FACTORS INCLUDED IN THE MODEL
The authors use several market-wide risk factors:
Equity Volatility
Measures stock market fluctuations.
Liquidity Spread
Difference between:
3-month Repo Rate
3-month Treasury Bill Rate
Change in Short-Term Yield
Change in Treasury Bill rates.
Yield Curve Slope
Difference between:
Long-term government bond yield
Short-term Treasury Bill yield
Credit Spread
Difference between:
Corporate bond yield
Government bond yield
Financial Market Returns
Overall stock market performance.
These factors help estimate how market conditions influence systemic risk.
12. FIRM-SPECIFIC DETERMINANTS OF SYSTEMIC RISK
The study examines ten financial characteristics.
1. Size
Measured as:
Logarithm of total assets.
Expected Impact
Positive
Reason:
Large institutions are highly interconnected.
Their failure can create larger shocks throughout the financial system.
2. Loan Ratio (LR)
Loans ÷ Total Assets
Measures asset concentration.
Expected Impact
Positive
Reason:
Heavy lending increases exposure to credit risk.
Poor diversification can increase systemic risk.
3. Loan Loss Provision Ratio (LLP)
Loan Loss Provisions ÷ Total Loans
Measures credit risk.
Expected Impact
Positive
Higher provisions indicate riskier loan portfolios.
4. Leverage Ratio (LEV)
Debt ÷ Equity
Measures dependence on debt financing.
Expected Impact
Positive
Higher leverage increases default probability.
5. Tier 1 Ratio (TR1)
Core Capital ÷ Risk-Weighted Assets
Measures capital strength.
Expected Impact
Negative
Higher capital absorbs losses and reduces systemic risk.
6. Liquidity Ratio (LQR)
Cash and Tradable Securities ÷ Deposits
Measures liquidity strength.
Expected Impact
Negative
Higher liquidity should protect firms during crises.
7. Market-to-Book Value Ratio (MTBV)
Market Value ÷ Book Value
Measures investor confidence and growth opportunities.
Expected Impact
Ambiguous
Can indicate:
Strong performance
Greater risk-taking
8. Non-Interest Ratio (NINT)
Non-interest Income ÷ Total Income
Measures dependence on non-traditional activities.
Expected Impact
Positive
More non-core activities can increase systemic risk.
9. Operating Profit Margin (OPM)
Operating Income ÷ Sales
Measures profitability.
Expected Impact
Ambiguous
Higher profits may:
Increase stability
OR
Encourage risk-taking
10. Deposit Ratio (DR)
Deposits ÷ Total Liabilities
Measures funding stability.
Expected Impact
Negative
Deposit-funded institutions rely less on volatile capital markets.
13. KEY FINDINGS: WHICH SECTOR IS MOST SYSTEMICALLY IMPORTANT?
The study finds:
1st Position: Banks
Banks are the largest contributors to systemic risk across BRICS countries.
They are:
More interconnected
More volatile
More likely to transmit shocks
2nd Position: Insurance Firms
In:
Brazil
India
Russia
South Africa
Insurance firms are the second most systemically important sector.
Exception: China
In China:
1. Banks
2. Financial Services
3. Insurance Firms
Financial service firms contribute more systemic risk than insurance companies.
14. COUNTRY-WISE SYSTEMIC RISK RESULTS
China
Most systemically risky banking sector.
Chinese banks contribute approximately:
ΔCoVaR = -0.41
Highest among all BRICS countries.
Chinese financial services also generate substantial systemic risk.
India
Insurance companies show significant volatility.
Insurance firms contribute approximately:
ΔCoVaR = -0.26
during financial distress.
15. MAJOR REGRESSION FINDINGS
Across BRICS countries:
The most important determinants of systemic risk are:
Positive Determinants
Increase systemic risk:
Institution Size
Liquidity Ratio
Operating Profit Margin
Market-to-Book Value Ratio
Negative Determinant
Reduces systemic risk:
Tier 1 Capital Ratio
This is the most consistent result across all countries and sectors.
16. COUNTRY-SPECIFIC FINDINGS
Brazil
Systemic risk increases with:
Larger size
More loans
Higher non-interest income
Higher liquidity
Higher market-to-book ratio
Systemic risk decreases with:
Higher Tier 1 capital
Interestingly:
Leverage ratio is not significant.
Russia
Systemic risk increases with:
Institution size
Loan ratio
Non-interest income
Profit margin
Systemic risk decreases with:
Tier 1 ratio
Leverage remains insignificant.
India
Systemic risk increases with:
Institution size
Loan ratio
Non-interest income
Leverage ratio
Systemic risk decreases with:
Tier 1 ratio
Operating profit margin (for banks and insurance firms)
Deposit ratio is generally insignificant.
China
Systemic risk increases with:
Size
Loan ratio
Liquidity ratio
Systemic risk decreases with:
Tier 1 ratio
Leverage and deposits show no significant effect.
South Africa
Systemic risk increases with:
Leverage
Non-interest income
Operating profit margin
Systemic risk decreases with:
Tier 1 ratio
Deposit ratio remains insignificant.
17. MOST IMPORTANT EXAM CRITICAL FINDINGS
Finding 1
Banks are the most systemically important financial institutions in BRICS.
Finding 2
Chinese banks contribute the highest systemic risk among all BRICS countries.
Finding 3
Tier 1 Capital Ratio consistently reduces systemic risk.
Finding 4
Larger institutions create greater systemic risk.
Finding 5
Greater involvement in non-core activities increases systemic risk.
Finding 6
Loan concentration often increases systemic risk.
Finding 7
Leverage is not universally significant across BRICS.
Finding 8
Insurance firms are the second-largest contributors to systemic risk in most BRICS countries.
Finding 9
Liquidity unexpectedly increases systemic risk in several BRICS countries.
Finding 10
Regulators should focus on firm-specific characteristics when designing macroprudential
regulations.
18. POLICY IMPLICATIONS
The study recommends that regulators should:
Monitor large financial institutions closely.
Enforce stronger Tier 1 capital requirements.
Supervise non-core income activities.
Monitor excessive lending and concentration risks.
Include firm-specific determinants in financial regulation frameworks.
Develop sector-specific systemic risk policies.
The authors argue that incorporating these determinants into regulatory frameworks can reduce
the cost of financial crises and improve financial stability in BRICS economies.
FINAL EXAM CRUX (MEMORIZE)
This study measures systemic risk in BRICS financial institutions using the ΔCoVaR model
for 2000–2015. It finds that banks are the largest contributors to systemic risk, followed by
insurance firms (except in China where financial services rank second). The most
important determinants of systemic risk are institution size, Tier 1 capital ratio, liquidity
ratio, operating profit margin, and market-to-book value ratio. Among these, Tier 1 capital
ratio consistently reduces systemic risk across BRICS countries, while larger institutions
generally increase systemic risk. The findings suggest that regulators should design policies
based on firm-specific risk characteristics to enhance financial stability and reduce
systemic vulnerability.