Volatility spillovers and capital buffers among the G-SIBs

Focus

The financial system is a public good, with banks at their heart. Shocks that hit one bank tend to spill over to other banks, and can cause a cascade of effects through to the whole economy. The more systemically important a bank is, the larger these spillovers are likely to be. More systemically important banks are therefore generally required to hold additional capital to reduce the overall riskiness of the banking system.

Contribution

We first estimate the size of spillovers between the volatility of equity prices in one bank and those in other banks. We then look to see if this is related to how systemically important the different banks are. We focus on the world's most systemically important banks, as identified by the Financial Stability Board.

Findings

We find a strong link between the size of volatility spillovers and how systemically important a bank is. We also find that banks with more capital have smaller spillovers to other banks, and the effect is stronger for more systemically important banks. Our results provide support for current policy, where higher capital standards for more systemically important banks help to reduce the riskiness of the banking system.

Abstract

We assess the dynamics of volatility spillovers among global systemically important banks (G-SIBs). We measure spillovers using vector-autoregressive models of range volatility of the equity prices of G-SIBs, together with machine learning methods. We then compare the size of these spillovers with the degree of systemic importance measured by the Basel Committee on Banking Supervision's G-SIB bucket designations. We find a high positive correlation between the two. We also find that higher bank capital
reduces volatility spillovers, especially for banks in higher G-SIB buckets. Our results suggest that requiring banks that are designated as being more systemically important globally to hold additional capital is likely to reduce volatility spillovers from them to other large banks.

JEL classification: C58, F65, G21, G28

Keywords: G-SIBs, contagion, connectedness, bank capital, cross validation