Systemic Risks and Financial Fragility in a Small Open Economy

This book contributes to a better understanding of financial system fragility in Bosnia and Herzegovina and similar countries in several ways. It is found that both country and period specifics must be accounted for. Accordingly, each country should develop its own tailored measure of systemic risk, since some of the widely used set of indicators may distort the perception of risk. There are substantial gains in modelling the risks of banking and currency crises as a system. It is demonstrated that even in a country with a simple financial system and dominant banking sector a single model cannot explain the evolution of systemic risk over the cycle. The nature of the risk factors, their relations with the perceived level of fragility, as well as the relationship between the measures of systemic risk were found to differ in pre-shock from the post-shock periods. Finally, it is shown that even simple financial systems are inherently unstable, with destabilizing relationships between the risks of banking and currency crises and developments in the real economy.