Monitoring Transmission of Systemic Risk from Shadow Banking to Regulated Banking

30 Pages Posted: 23 Jul 2015 Last revised: 28 Jul 2016

See all articles by Necmi K. Avkiran

Necmi K. Avkiran

University of Queensland - Business School; Financial Research Network (FIRN)

Christian M. Ringle

Hamburg University of Technology (TUHH)

Rand Low

University of Queensland

Date Written: July 22, 2015

Abstract

There is a need to introduce a statistical method to the toolkit of the regulators that is versatile, easy-to-use and can handle complex cause-effect phenomena that are not directly observable or measurable, i.e. latent constructs. In a first application of partial least squares structural equation modeling (PLS-SEM) in financial stress testing, we demonstrate how this technique can be used to explain transmission of systemic risk. We model transmission of systemic risk from shadow banking to the regulated banking sector by a set of indicators (directly measurable variables) that are causes of systemic risk in shadow banking and consequences of systemic risk observed in the regulated banking sector. Procedures followed for predictive model assessment using PLS-SEM are outlined in clear steps for the benefit of those unfamiliar with this technique. Results indicate that around 75% of the variation in systemic risk in the regulated banking sector can be explained by micro and macro-level linkages traced to shadow banking. The path coefficients between the two exogenous latent constructs (i.e. systemic risk in shadow banking separately sourced from micro and macro-level linkages) and the endogenous latent construct (i.e. systemic risk in the regulated banking sector) are statistically significant. Regulators can use the approach illustrated in this article to monitor transmission of systemic risk appreciative of the extent of contagion emanating from micro and macro-level linkages, thus guiding microprudential versus macroprudential regulatory decisions. Skills demonstrated in this article are transferable to any finance topic or discipline where latent constructs are found.

Keywords: PLS-SEM, structural equation modeling, contagion of systemic risk, shadow banking, regulated banking

JEL Classification: E5, F3, G2, L5

Suggested Citation

Avkiran, Necmi K. and Ringle, Christian M. and Low, Rand, Monitoring Transmission of Systemic Risk from Shadow Banking to Regulated Banking (July 22, 2015). 28th Australasian Finance and Banking Conference, Available at SSRN: https://ssrn.com/abstract=2634184 or http://dx.doi.org/10.2139/ssrn.2634184

Necmi K. Avkiran (Contact Author)

University of Queensland - Business School ( email )

Brisbane, Queensland 4072
Australia

Financial Research Network (FIRN) ( email )

C/- University of Queensland Business School
St Lucia, 4071 Brisbane
Queensland
Australia

Christian M. Ringle

Hamburg University of Technology (TUHH) ( email )

Am Schwarzenberg-Campus 4
Hamburg, 21073
Germany

HOME PAGE: http://www.tuhh.de/hrmo

Rand Low

University of Queensland ( email )

St Lucia
Brisbane, Queensland 4072
Australia

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