Fields Financial and Economics
The article under review is titled “Interconnectedness of the Banking Sector as Vulnerability to Crisis” authored by Peltonen, Rancan ; Sarlin (2018) which aims at studying the connection of the relationship to the financial crises experienced in the European banking sector. The research follows a series of publication by the three authors who play active roles in the economics and academic sectors. Sarlin is an author and a professor at the Hanken School of Economics and a director at Risklab, Finland. Rancan, on the other hand, works at the European Commission’s Joint Research Center (JRC) in Italy. Peltonen leads the European Systematic Risk Board (ESRB) as a deputy’s head. The research followed the financial crises experienced in the banking sector specifically in Europe and aimed at determining the role played by the central positioning of the financial institutions. The relevance of the article to the course is due to the insight offered in the world economics and the influence of the macroeconomics created by the connectivity within banks to both financial and non-financial market fragmentations. Finally, the intended audience includes policymakers and scholars in the economics fields.
Interconnectedness of the banking sector
Following the global crisis in the financial institutions, researchers embarked on a mission to provide insight into the causes of risks in the banking systems and determining the indicators of financial predicaments. According to Peltonen, Rancan ; Sarlin (2018), the study focused on identifying gradual risks and a cross-sectional dimension of vulnerable situations to explore the relationship between banks interconnection and macro-financial signs to the European-banking crisis. The reason for leaning towards countries in Europe was the central role played by the banks in channeling funds to the general economy, together with the spillover effects of the use of a single currency in trade.
The study focuses on the complex web created by banks interconnection and the effects they have in making the banking system vulnerable to impending crises. In addition, the article aims at determining the risks associated with cross-border banking in the event of a collapse to the international banking sector. The backbone of the research borrows on previous research by Castren ; Rancan (2014) on the concept of micro-networks, a phenomenon that connects different financial and non-financial institutions in an economy. These institutions include financial intermediaries, banks, pension funds, insurance companies, governments, and households.
Data used in the study include dates that financial crises occurred in all European Union countries between 1970 and 2012. Next was the early-warning indicators in the country level, which included imbalances, vulnerabilities, and risks. The third set comprised of macro networks form the Euro Area Accounts (EAA) that connected each banking system to other institutions in the economy (Peltonen, Rancan ; Sarlin, 2018).
The methodology applied consisted of constructions of macro networks for the 14 countries selected and the links between the banking sectors with other institutions in each member country. In addition, the analysis measured the centrality possessed by the financial institutions to ascertain the threats banks faced because of its domestic and cross-border interconnections.
The results presented in the research indicates that the banking system centrality plays a key role in determining the vulnerability of the system to crises. The conclusion is supported through the measure of financial instruments in banks such as deposits, shares, loans and deposits, and the risks faced by the institutions through liquidity, funding, credit, and other threats in the market. In addition, the interconnection of banks remains less significant in indicating crisis signals as compared to the role of the bank. However, the domestic and international linking of the institutions in a way also contribute to the problems faced by the banks. Consequently, early warnings of the financial crisis in banks vary form loans, deposits, securities, and shares with each representing a different indicator (Peltonen, Rancan ; Sarlin, 2018).
The authors fulfilled their purpose by logically expressing the research. In addition, accurate and relevant data was presented by intergrading the works of previous authors in the same study. The definition of terms and economic jargon was clearly defined and sound interpretation made. Finally, the authors achieved their purpose in determining the vulnerability of financial systems associated with the interconnections of banks.
I agree with the authors on the vulnerability of the banking systems based on the central role they play in the economy. Based on the various functions financial institutions perform in channeling funds to other sectors of the economy, banks remain exposed to changes in the market and other risks associated with lending. Secondly, the interconnection of banks and cross-border links present savings to crisis indicators in the international bank sector. According to a report by International Monetary Fund (2010), financial globalization since the mid-1990s has contributed to the linking of global financial institutions. While the relationship has produced benefits, it has also introduced risks especially because market failure and illiquidity in one economy can translate to the worldwide market.
However, Baratierri ; Moretti (2016) differ with the research model conducted by the article in that it fails to address the relationship between interconnectivity and leverage in the banking system. Instead, they propose a model in which financial institutions can avert risks through securitization whereby banks trade-off debt lower cost with leveraging risk. In addition, the article fails to offer a solution to the risks associated with the positioning of the banking sector in the economy to avoid the risks associated with their functions.
Application in an Organization
Today banking systems remain connected in both the domestic and international markets. Because of these interconnections, a significant drop in one demand affects another economy across borders. An instance is the use of the U. S dollar, and the effects fluctuation in prices affects other economies across the globe. Interconnectedness in the Caribbean has seen the dominance of Canadian banks in the region’s financial platform. The relationship has increased offshore borrowing by local banks for domestic use. In addition, the Eastern Caribbean Currency Union provides a common trade currency for member states sharing a universal central financial institution, government security market, and stock exchange platform (Ogawa, Park, Singh, & Thacker 2013).
Although interconnectedness in the banking sector exposes economies to vulnerability, the relationship played a crucial role in risks pooling and linked mediation of savings. However, insufficient research remains in the field of interconnectedness, and therefore it calls for the collaboration of stakeholders in determining early-warning indicator effects on the global scale. Consequently, the position and role of the banking sector remain the leading cause of crises in the economy and therefore research should focus on introducing ways for the institutions to avert the risks.
Baratierri, A., & Moretti, L. (2016). Bank Interconnectivity and Leverage. Retrieved from http://www-bcf.usc.edu/~quadrini/papers/BankConnectivityCastrén, O., & Rancan, M. (2014). Macro-Networks: An application to euro area financial accounts. Journal of Banking & Finance, 46, 43-58. doi:10.1016/j.jbankfin.2014.04.027
Ogawa, S., Park, J., Singh, D., & Thacker, N. (2013). Financial Interconnectedness and Financial Sector Reforms in the Caribbean. IMF Working Papers, 13(175), 1. doi: 10.5089/9781484307830.001
Peltonen, T., Rancan, M., & Sarlin, P. (2018). Interconnectedness of the banking sector as a vulnerability to crises. International Journal Of Finance & Economics. doi: 10.1002/ijfe.1701
Understanding Financial Interconnectedness. (2010). Retrieved from https://www.imf.org/en/Publications/Policy-Papers/Issues/2016/12/31/Understanding-Financial-Interconnectedness-PP4503