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NERA Report: Interconnectedness Key to Systemic Risk Legislation

Source: PCI

Posted on 03 May 2010

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The Property Casualty Insurers Association of America (PCI) has unveiled the second report by NERA Economic Consulting which demonstrates the importance of considering financial system interconnectedness in systemic risk and resolution legislation.

The NERA study, "De-Mystifying Interconnectedness: Assessing 'Too Interconnected to Fail' and the Fallout from Getting it Wrong" calls for a more balanced approach to addressing systemic risk regulation and resolution authority in financial services regulatory reform legislation. Release of the study comes as the Senate finalizes their sweeping regulatory reform measures.

"Interconnectedness, which varies significantly across institutions, is a key determinant of a financial firm's contribution to systemic risk,” said Christopher Laursen, senior consultant for NERA. “Any program designed to limit future systemic crises must assess the scope and scale of firms’ interconnectedness to ensure that efforts are properly targeted. Imposing new cost burdens on businesses that are not significantly interconnected will unnecessarily result in higher costs being passed on to consumers.”

The NERA paper describes financial system interconnectedness and its importance to systemic risk. It also details the negative consequences associated with a failure to consider varying levels of interconnectedness across financial firms in regulatory reform efforts. These economic impacts include:

I. Inefficient Regulation and Competing Mandates

II. Increased Legal and Market Uncertainty

III. Inefficient Capital Structure and Increased Cost of Capital

IV. Reduced Transparency and Increased Risk

V. "Free-Riders" and Loss of Economic Efficiency

VI. Adverse Incentives and New Additional Moral Hazard

VII. Undermined Market Discipline

VIII. U.S. Job Losses and Decline in U.S. Competitiveness

“We hope that Congress can use these findings as a tool as deliberations over systemic risk and resolution regulation continue,” said David A. Sampson, president and CEO of PCI. “The NERA study shows that a broad-based systemic risk regime that fails to properly account for interconnectedness would result in an increase in unemployment and a loss of U.S. competitiveness. This is a critical time for our nation’s financial markets and insurers remain committed to seeking appropriate solutions for identifying systemic risk and protecting consumers.”

PCI engaged NERA in December 2009 to produce third-party analysis to examine systemic risk regulation. PCI commissioned a series of studies to establish scientific methods to assess and define systemic risk. The first study, “Problems With Reliance On Firm Size For Systemic Risk Determination” was released in February 2010. The NERA report was commissioned by PCI, but NERA’s experts are wholly responsible for its content and conclusions.

NERA Economic Consulting ( is a global firm of experts dedicated to applying economic, finance, and quantitative principles to complex business and legal challenges. For nearly half a century, NERA’s economists have been creating strategies, studies, reports, expert testimony, and policy recommendations for government authorities and the world’s leading law firms and corporations. With its main office in New York City, NERA serves clients from over 20 offices across North America, Europe, and Asia Pacific.