The financial crisis of 2007-2008 has highlighted once again the importance of risks to the stability of the financial system. Systemic risk in the banking sector is of great concern due to the public externalities of the banking industry such as the maintenance of the payment system.
During the aftermath of the financial crisis an impressive literature has emerged on how to measure and quantify systemic risk. The aim of this paper is to provide a comprehensive framework for the evaluation of bank systemic risk and individual bank risk by regulators and supervisors. We advance a number of social risk functions by which the systemic features can be judged and show how these can be used to evaluate the risk of the banking sector. Alternative criteria weigh the systemic and individual bank risks differently. Subsequently, we turn to empirical analyses on a per individual bank basis and per country basis and detect important differences across banks and countries.
The new Basel III Accord of December 2010 still has predominantly a microprudential focus, trying to prevent individual bank failures which is consistent with a social risk function focusing on the weakest link or worst-off individual bank. But other criteria place more emphasis on and weigh the systemic part lighter. Therefore, bank supervisors will have to specify explicity their social risk function in order to set bank capital requirements.