"Too Big To Fail"

Steering clear of systemic risk

Posted on Wednesday, October 27, 2010

Systemic risk is the threat that the failure of one financial institution causes significant disruption to, or even the collapse of, the broader financial system.

The keystone of systemic risk is banking for two main reasons: banks are highly interconnected by thousands of loans and other contracts; and they are heavily dependent on short-term funding from depositors and markets that can flee at the first sign of trouble, causing a run on a bank.

The main reason insurers are not thought to pose a systemic risk is because they do not operate in this way. They are not as highly leveraged as banks, are less interconnected and are extremely unlikely to suffer a run.

Policyholders cannot simply pull their money out of an insurer. Following an accident or loss they need to make a claim, and often face stiff financial penalties if they wish to cancel a life insurance or savings policy.
Financial regulators are turning their attention towards new rules to monitor financial stability and systemic risks through so-called macro-prudential supervision, which aims to set safe levels of capital and operating rules for the whole financial system rather than individual businesses.
Yoshihiro Kawai, IAIS secretary-general, argues that insurance regulators must develop better supervision and address gaps across financial industry oversight.
“We need a broader view of not just insurers, but of the overall economy and potential build-up of risk as a totality,” he says.
“Insurance supervisors should have a global view and not just a snapshot but a film-like [ongoing] picture of the insurance markets. We need to develop this urgently.”
Bodies such as the Financial Stability Board, run in part by the Bank of International Settlements, and the new US Financial Stability Oversight Council are developing lists of the world’s most systemically important financial institutions to ensure these are properly and prudently capitalised and monitored.
Large, multinational insurers are worried about being included on such lists as it is likely to result in having to hold more capital and face additional regulatory costs.
Carlos Montalvo-Rebuelta, secretary-general of the committee of European insurance and occupational pensions supervisors, the main European regulatory body, says it is not necessarily individual insurers who are systemically relevant, but the insurance sector as a whole.
“The misleading debate for insurers is what is happening in banking about whether individual firms are systemically relevant and whether they should hold more capital,” he says.
“This is not necessarily the right way to approach individual insurers.”

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