Pitfalls in Systemic-Risk Scoring

We identify several shortcomings in the systemic-risk scoring methodology currently used to identify and regulate Systemically Important Financial Institutions (SIFIs). Using newly-disclosed regulatory data for 119 US and international banks, we show that the current scoring methodology severely distorts the allocation of regulatory capital among banks. We then propose and implement a methodology that corrects for these shortcomings and increases incentives for banks to reduce their risk contributions. Unlike current scores, our adjusted scores are mainly driven by risk indicators directly under the control of the regulated bank and not by factors that are exogenous to the bank, such as exchange rates or other banks' actions.

Perignon C., Hurlin C., and Benoit S. (2019) Pitfalls in Systemic-Risk Scoring. Journal of Financial Intermediation.