Understanding of systemic risk vital to avoiding future financial crises

The paper, presented at a meeting of the Institute of Actuaries on 7 December 2009, shows just how risks materialising in one part of the financial system can have a widespread impact, affecting other financial markets and institutions and the broader economy.

By examining a number of historic financial crises, the paper discusses what constitutes a systemic event and, importantly, considers how policy makers can respond to the risk of such systemic financial failures.

Paul Sweeting, Professor of Actuarial Science at the University of Kent and chair of The Actuarial Profession’s Global Financial Crisis Group, welcomed the research, saying: “It may be a cliché to say that we must learn from the mistakes of history, but in this instance it rings true. As we begin to enter the post-crisis financial landscape, this research will help us chart our course with greater confidence.”

He added: “The important feature of this paper is that it does more than just explain how this crisis came about - it also makes clear policy recommendations that could limit the chances of such a crisis occurring again. In particular, it says what firms themselves should do to protect themselves in times of financial stress.”

The paper makes five recommendations:

• Regulations should never force firms to sell assets in such a way that could force assets into a downward spiral;
• Financial firms should hold extra capital for times of stress, or have ex ante arrangements to raise this capital;
• Regulations should make firms consider systemic risks;
• Financial firms should have back-up contracts in place for the derivatives they hold;
• Financial firms should disclose information to allow regulators to assess levels of systemic risk.

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Enquiries: Tel. Michael Scanlan on 020 7632 1453 or email michael.scanlan@actuaries.org.uk

Notes to Editors

1. Actuaries provide commercial, financial and prudential advice on the management of a business’s assets and liabilities, especially where long term management and planning are critical to the success of any business's venture. They also advise individuals, and advise on social and public interest issues.
2. Members of the Profession have a statutory role in the supervision of pension funds and life insurance companies. They also have a statutory role to provide actuarial opinions for managing agents at Lloyd’s.
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