De-Mystifying Interconnectedness: Assessing 'Too Interconnected to Fail' and the Fallout from Getting it Wrong

Fri Apr 23 16:24:00 EDT 2010
By Dr. Sharon Brown-Hruska and Dr. John Bovenzi of Oliver Wyman Group, et al.

In this report, the second in a series prepared for the Property Casualty Insurers Association of America (PCI), the authors call for a more balanced approach to addressing systemic risk regulation and resolution authority in financial services regulatory reform legislation. The report describes financial system interconnectedness and its importance to systemic risk. It also details the negative consequences associated with a failure to consider varying levels of interconnectedness across financial firms in regulatory reform efforts. These economic impacts include: inefficient regulation and competing mandates; increased legal and market uncertainty; inefficient capital structure and increased cost of capital; reduced transparency and increased risk; "free-riders" and loss of economic efficiency; adverse incentives and new additional moral hazard; undermined market discipline; and US job losses and decline in competitiveness. PCI engaged NERA in December 2009 to produce third-party analysis to examine systemic risk regulation, commissioning a series of studies to establish analytical methods to assess and define systemic risk. The first study, Problems with Reliance on Firm Size for Systemic Risk Determination, was released in February 2010.