Systemic Risks and Multilayer Financial Networks: from Contagion to Mitigation

The global financial system's interconnectedness has increased due to globalization, technological advancements and the integration of financial markets. Financial institutions and markets across different countries are more closely linked than ever before; while this interconnectedness facilitates global trade and investment, it also means that financial turmoil can quickly spread from one country to another. Systemic risk is the possibility that an event at the company level could trigger severe instability or collapse an entire industry or economy. The fall of Lehman Brothers in 2008 showed that the failure of a single entity could have far-reaching effects on the global financial system. This chapter innovatively interprets the financial system as a complex network formed by the relationships among various “nodes”: banks, financial institutions, markets, and consumers. These networks are intricate and opaque, making it challenging to understand and predict how risks and failures in one part of the system can affect the rest with a domino impact. In managing systemic risk, regulators and policymakers play a vital role, implementing stricter regulatory frameworks, overseeing financial institutions more closely, and developing mechanisms to identify and mitigate risks early. This chapter shows that effective strategies to mitigate systemic risk involve better risk assessment models, more robust regulatory frameworks, and international cooperation among regulatory bodies. Stress testing, capital adequacy requirements, and monitoring of “too big to fail” institutions, as well as of “too interconnected to fail” ones, are part of these strategies, that may usefully consider network theory to link economic agents to their edging patterns.