Prudential policies and systemic risk: The role of interconnections

Journal of International Money and Finance. 2022. Vol. 127. Article 102696.

Karamysheva M., Seregina E.

The impact of prudential policies in open economies depends on their intrinsic efficacy and the spillovers from the close financial partners. Using a sample of advanced economies, we find that prudential policy interventions significantly reduce systemic risk in the financial systems with the impact amplified through a network of financial investment links. Using the Spatial Autoregressive (SAR) model we show that the indirect (network) effect enforces the direct effect and accounts for up to 87% of total risk reduction assuming the uniform policy interventions. We are the first to perform a spillover analysis for prudential policies and uncover the importance of financial network and uniform interventions for the reduction of systemic risk.

Keywords: banking regulation, networks, macroprudential policy, systemic risk