Distributing Risk with Digital Assets: Mitigating Global Systemic Risk

by John Dwyer, October 27, 2015
Industry Trends
Global, EMEA

Abstract

Since the global financial crisis of 2008, policymakers, regulators, and market participants have increasingly shifted their attention to the notion of systemic risk. While significant research has been put into defining systemic risk and establishing a means for measuring its build-up, little attention has been given to how we harness technology to re-architect the financial system to retain counterparty risk but limit its ability to turn into something systemic.

In this report, Celent will explore how distributed ledger technology may offer a solution to this problem.

Growth in Financial Crises

In the past few decades our global financial system has faced numerous financial disasters that have grown in size, scope, and breadth of financial impact, culminating in the global financial crisis of 2008 that triggered the largest globally coordinated bailout in history, costing trillions of dollars.

Market Uncertainty when Certainty Is Critical

Capital markets hate uncertainty, particularly in distressed periods. The absence of accurate, real-time information on the interconnectedness of financial institutions provides a real problem to regulators as they seek to provide reassurance to the market during a crisis.

Distributed Ledger Technology

Celent explores several areas in this report including systemic risk, central bank prudential regulation, interbank payments, capital markets settlement, and the potential benefits of distributed ledger technology to mitigate systemic risk.

“We remain at the early stages of the evolution of this technology,” says John Dwyer, a senior analyst with Celent’s Securities and Investments practice and author of the report. “However, we deem it important for our clients to have the perspectives provided in this report because we see the potential for some fundamental re-architecture of not only information technology within the financial system but of the global financial system itself.”

Celent is a research and advisory firm dedicated to helping financial institutions formulate comprehensive business and technology strategies. Celent publishes reports identifying trends and best practices in financial services technology and conducts consulting engagements for financial institutions looking to use technology to enhance existing business processes or launch new business strategies. With a team of internationally based analysts, Celent is uniquely positioned to offer strategic advice and market insights on a global basis. Celent is a member of the Oliver Wyman Group, which is part of Marsh & McLennan Companies [NYSE: MMC].

Media Contacts

North America
Michele Pace
mpace@celent.com
Tel: +1 212 345 1366

Europe (London)
Chris Williams
cwilliams@celent.com
Tel: +44 (0)782 448 3336

Asia (Tokyo)
Yumi Nagaoka
ynagaoka@celent.com
Tel.: +81 3 3500 3023

Table of Contents

Executive Summary

1

Systemic Risk

3

 

Introduction

3

 

Overview

3

 

Terminology

4

 

Endogenous Risk

5

 

Growth in Financial Crises

5

Causes of Systemic Risk

8

 

Global Leverage

8

 

The Global Carry Trade

9

 

Fractional Reserve Banking

10

 

Rehypothecation

10

 

Scarcity of High Quality Collateral and Bond Duration

11

 

Concentration of Risk and SIFIs

12

 

Market Uncertainty when Certainty Is Crucial

13

Distributed Risk Markets and Digital Asset Ledgers

14

 

Distributed Systems

14

 

Fiat Currency on a Distributed Ledger

15

 

Direct Ownership of Financial Assets

17

 

Distributed Risk Markets

18

 

Regulation and Decentralization

19

 

Conclusion

23

Leveraging Celent’s Expertise

24

 

Support for Financial Institutions

24

 

Support for Vendors

24

Related Celent Research

25

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