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Revisiting Interconnectedness: Emerging Risks and the Global Financial System

By DTCC Connection Staff | 4 minute read | July 22, 2022

We live in an interconnected global financial marketplace driven by technological transformation. As our industry continues to evolve, the risk landscape has changed rapidly, profoundly leading to dramatic shifts in the interconnected risk threat faced by businesses. Given the increasing complexity and interconnectedness of the global financial system, it is more important than ever to manage risks holistically.

Related: DTCC Systemic Risk Barometer Survey Identifies Potential Threats

We recently released Interconnectedness Revisited, a white paper highlighting emerging systemic risks that are associated with recent changes in how the global financial system is interconnected. In this paper, we highlight how the global interconnectedness risk landscape has changed rapidly and profoundly over the past few years, particularly across five areas: Cross-Border Exposures, Non-Bank Financial Intermediation Sector, Operational Exposures, Financial Technology, and Financial Market Infrastructures (FMIs).

Read below for a high-level summary of how systemic risks are impacted by the interconnectedness of these areas:

Cross-Border Exposures

  • Systemic Summary: The interconnectedness created by banks’ cross-border positions, while beneficial in many ways, provides a transmission mechanism that can propagate shocks across the global financial system.
  • Cross Border Exposures
  • Macro Matters: The International Monetary Fund (IMF) analysis, which investigates how the structure of the global financial network has changed since the global financial crisis (GFC) in 2007, highlighted three notable observations: the significant increase in China’s importance, the steadying influence of the U.S., and the greater concern from shocks encompassing the entire euro area.
  • Key Takeaway: Greater cross-border interconnectedness has made countries that rely heavily on foreign capital inflows more vulnerable to systemic shocks.

Non-Bank Financial Intermediation Sector

    Non-Bank Financial Institutions
  • Systemic Summary: Non-bank financial institutions, which include insurance firms, venture capitalists and currency exchanges, among others, are interconnected with banks through a series of direct and indirect links.
  • Sector Surge: While the financial assets of the banking sector have grown by 56% from 2010 to 2020, those of the NBFI sector have increased by 94% (to $226.6 Tn) over the same period.
  • Key Takeaway: The growing importance of Non-Bank Financial Intermediation has increased the potential role that this sector might play in transmitting stress throughout the financial system.

Operational Exposures

    Operational Exposures
  • Systemic Summary: While financial interconnectedness was prioritized in the aftermath of the GFC, operational interconnectedness has been rising on the regulatory agenda because of the growing use of outsourcing and the increased importance of third and fourth parties.
  • Cyber Statistic: 45% of large financial services companies experienced a rise in cyber-attack attempts since the onset of the COVID-19 pandemic.
  • Key Takeaway: The growing reliance on third-party vendors and the ever-increasing proliferation of cyber threats has created yet another channel of risk transmission that may have systemic implications.

Financial Technology

  • Systemic Summary: The scope of fintech-related applications is extremely broad and encompasses a wide array of innovative technologies, business models and applications, from cloud computing to machine learning and artificial intelligence. As such, the impact of fintech on financial interconnectedness is a multi-faceted topic.
  • Financial Technology
  • Crypto Capitalization: The total cryptocurrency market capitalization surged from just $17.7 billion at the start of 2017 to slightly over $3 trillion in early November 2021, before falling back below the $2 trillion mark in early 2022.
  • Key Takeaway: As fintech innovations continue to change financial services and as cryptocurrencies are starting to become more interconnected with the global financial system, a new set of financial stability challenges may be emerging.

Financial Market Infrastructures (FMIs)

  • Systemic Summary: FMIs are interconnected with the financial ecosystem, which could provide channels for risk transmission.
  • Financial Market Infrastructures
  • Domino Effect: Based on an analysis performed by the Study Group on Central Clearing Interdependencies (SGCCI), exposures to central counterparties (CCPs) are concentrated among a small number of entities. The largest 11 out of 306 clearing members are connected to between 16 and 25 CCPs, indicating that the default of a CCP’s clearing member could result in defaults of the same entity or affiliates in up to 24 other CCPs included in this analysis.
  • Key Takeaway: FMIs themselves are interconnected with the financial ecosystem in a myriad of ways, which presents its own set of risk management challenges. DTCC has taken various initiatives to reduce these risks.