Good for one, bad for all: Determinants of individual versus systemic risk

• Unstable source of funding is the main factor driving systemic risk.
• Combining investment bank activities with presence in foreign markets appears to exacerbate financial instability.
• Whereas trading activities contribute to the build-up of correlated risk they help shed away individual solvency risk.
• A decentralized approach to liquidity management seems to alleviate individual solvency risk.
• A decentralized approach to liquidity amplifies the transmission of financial distress across the financial system.

We analyze a sample of large international banks in major advanced economies and examine the impact that bank-specific factors have on an institution's solvency risk and its contribution to systemic risk. We focus on the five categories that the Basel Committee on Banking Supervision has recently proposed as indicators of systemic importance. Our findings suggest that unstable funding is the main factor driving systemic risk. Furthermore, the combination of significant trading activities with global presence appears to exacerbate spillover risks to the global financial system. Interestingly, whereas trading activities contribute to the build-up of correlated or ‘wrong-way’ risk they help to mitigate individual solvency risk. Conversely, a decentralized approach to liquidity management seems to alleviate individual solvency risk but amplifies the transmission of financial distress across the financial system. This suggests that a macro-prudential approach to financial regulation should focus not only on scaling up micro-prudential measures but also on enabling the efficient transfer of risk between financial institutions.