The Depository Trust & Clearing Corporation (DTCC) has released a white paper today exploring the role of interconnectedness in the transmission of risk and offering practical guidelines for risk management professionals.
Interconnectedness, or the relationship among economic agents that are created through financial transactions and supporting arrangements, is a key dimension of systemic risk and has become a critical topic for market participants and regulators following the 2008 financial crisis.
Most research completed to date has found that financial networks tend to be robust yet fragile, absorbing shocks up to a certain tipping point, and spreading risk beyond this critical threshold. These studies also reveal that the relationship between interconnectedness and network resilience is extremely complicated; while a moderate level of interconnectedness helps diversify risks, a very densely connected network may be less robust and spread shocks rather than absorb them.
Regulators have made progress in addressing interconnectedness risks and have adopted an approach that primarily focuses on increasing the resilience of the most interconnected – and most systemically important – financial institutions. Market participants must also assess and respond to this risk. The white paper recommends that market participants take actions, including making a comprehensive inventory of external entities on which they rely and then prioritising and identifying how the failure of an external entity would impact their business in its entirety. Managing these exposures holistically and cooperating across departments will help businesses to manage interconnectedness risk in a more effective manner.
“Given the systemically important nature of its services and infrastructure, DTCC is at the forefront of the progress being made on interconnectedness and has been working collaboratively with market stakeholders to address systemic issues and challenges facing the industry,” says Michael Leibrock (pictured), DTCC’s Chief Systemic Risk Officer.
“We believe that incorporating an interconnectedness lens into risk management activities can meaningfully contribute to enhancing systemic resilience, both for individual organisations and for the financial industry as a whole,” says Andrew Gray, DTCC’s Group Chief Risk Officer.
Identifying and assessing interconnectedness risks promotes a broader and deeper understanding of the threats to an organisation. The white paper proposes a set of practical guidelines developed for practitioners who wish to adopt this approach as a way to manage risks more holistically across organizational silos.
