Identifying systemically important financial institutions: a network approach

The Basel Committee on Banking Supervision has proposed a methodology to identify Systemically Important Financial Institutions based on a series of indicators that should account for the externalities that these institutions place into the system. In this article we argue that the methodology chosen by Basel III maintains the micro-prudential focus of Basel I and II.

We show how the PageRank algorithm that operates behind the Google search engine can be modified and applied to identify Systemically Important Financial Institutions. Being a feedback measure of systemic importance, the PageRank algorithm evaluates more than individual exposures. The algorithm is able to capture the risks that individual institutions place into the system, while at the same time, taking into account how the exposures at the system-wide level affect the ranking of individual institutions.

In accordance to the Basel III framework, we are able to distinguish between systemic importance due to exposures born on the asset and on the liability side of the balance sheet of banks.