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Commission-backed project to help identify systemic financial market risks

The European Commission is investing in a research project to develop new systemic risk indicators for “early warning systems” that could alert governments and bankers to impending financial crises in the earliest stages and take early action to stop them from spreading.

Researchers from universities in Italy, Spain, Switzerland and the UK, experts at Yahoo! and the European Central Bank will investigate how financial institutions are exposed to systemic risk as a result of complex, highly inter-connected digital information and transaction systems. Based on a new multi-disciplinary research approach, the project will analyse the complex system of global, ICT-based financial transactions, along with internet search queries, to monitor the build-up of risk in the financial system and the economy as a whole.

Commission Vice-President for the Digital Agenda Neelie Kroes said "This new research aims to allow better monitoring of financial markets by focussing on systemic risks arising from the highly inter-connected digital information and transaction systems in the financial markets."

Today's financial institutions are mutually interconnected in a complex web of computer-based transaction systems. In such a strongly interconnected system, if a financial institution fails, there can be a risk that a "domino effect" could lead to problems for other institutions, even financially healthy ones. One reason why the severity of the recent financial crisis was not adequately predicted was because existing tools and data did not allow experts to sufficiently consider the extent to which the sector relies on these complex interactions and mutual exposures.

The aim of the "Forecasting Financial Crises" project is to improve policy makers' understanding of how banking systems, stock markets and the flow of credit are mutually interconnected. The conceptual and software instruments developed during the research could help develop early-warning systems that would permit actions to be taken if needed to stabilise financial markets. The research will focus not only on financial transaction data, but also on internet search data such as the frequency of certain key words related to finance in search engines. The aim is to develop new risk indicators that could be used by policy bodies like the European Central Bank, the European Systemic Risk Board, or the Basel Committee on Banking Supervision to help to prevent future financial crises.

The approach is based on new multi-disciplinary research, linking results from complex systems science and the physics of stability and resilience to modern approaches in economics. The resulting ICT-based tools would complement the far-reaching measures taken in Europe in response to the recent financial crisis to step up regulation of financial institutions and to increase monitoring and supervision of markets. (BBJ)