Government of India Volume I: Analysis and Recommendations

CHAPTER 9
Systemic risk
9.1. The problem of systemic risk
The field of financial regulation has traditionally focused on consumer protection, microprudential
regulation and resolution. However, the 2008 financial crisis highlighted systemic
risk as another important dimension of financial regulatory governance. Subsequently,
governments and lawmakers worldwide have pursued regulatory strategies to
avoid such systemic crises and reduce the costs to the exchequer, and ultimately society,
of resolving the crises that do occur.
Systemic risk is the risk of a collapse in the functioning of the financial system, largely
due to its interconnectedness to other parts of the economy, leading to an adverse impact
on the real economy. Thinking about systemic risk oversight requires an integrated
and comprehensive view of the entire financial system. In comparison, conventional financial
regulation leans towards analysing consumers, financial products, financial firms
or financial markets, one at a time.
The Commission recommends the IMF-FSB-BIS definition of systemic risk:
[a] risk of disruption to financial services that is caused by an impairment of all
or parts of the financial system and has the potential to have serious negative
consequences for the real economy.
The primary regulatory mandate of regulators and agencies defines their perspective
and information access, so an individual sectoral regulator is likely to focus its gaze or
have a viewpoint on the operations of that sector alone, and not on the overall financial
system of the country. For example, a resolution corporation tends to look at firms from
the narrow perspective of how an individual firm would be resolved when in distress and
this perspective informs its approach to the financial system. Systemic risk analysis, in
contrast, requires a comprehensive system-wide perspective on the impact of the failure
of an individual firm or sector.
The analysis of the Commission regarding systemic risk reflects a combination of:
1. India’s experiences with several systemic crises from 1992 onwards;
2. The emerging global consensus on methods for avoiding systemic crises that have come into focus after the
2008 financial crisis; and
3. The analysis of scenarios involving potential systemic crises in coming decades in India.
To some extent, systemic crises are the manifestation of failures in the core tasks of
financial regulation – consumer protection, micro-prudential regulation and resolution.
FINANCIAL SECTOR LEGISLATIVE REFORMS COMMISSION 89