Policies believed to stabilize the financial system may actually do the opposite, study finds

Stability of the network of the top 50 European banks. Credit: Bardoscia et al. Published in Nature Communications

(Phys.org)—Researchers have found that some of the current financial policies aimed at increasing the stability of financial networks may actually be driving them toward instability. The problem arises because these policies typically focus on the stability of individual banks—but due to the complex nature of networks, what"s good for individual banks may not be good for the banking system as a whole.

The good news is that the results may make it easier to assess the stability of the financial system, since they suggest that regulatory authorities should be focusing on the big picture (composed of market-scale information that is freely available), and not details from individual banks (which require lots of data and the continued cooperation of banks to supply it).

The researchers, Marco Bardoscia et al., have published a paper on their findings regarding the instability in financial networks in a recent issue of Nature Communications.

"The fact that the attempt to reduce individual risk can actually increase systemic risk had been discussed before in the context of financial contagion," Bardoscia, at the University of Zurich and the London Institute for Mathematical Sciences, told Phys.org. "The paper explains why this happens, which is through the emergence of peculiar cyclical structures in the network of contracts among banks, and it makes the point that some policies can have the unintended consequence of facilitating the emergence of such structures, thereby creating the ground for future instabilities."