The Intrafirm Complexity of Systemically Important Financial Institutions

TL;DR

This paper proposes a network-based measure of financial institutions' complexity using control hierarchies, aiding in SIFI designation and potentially guiding firms to manage their complexity levels.

Contribution

It introduces a novel quantitative approach to measure firm complexity through control hierarchy networks, enhancing SIFI identification and regulatory assessment.

Findings

SIFIs have decreased their complexity over the past two years.

Control hierarchy metrics provide a consistent complexity comparison across firms.

The approach offers a foundation for firms to manage and reduce complexity.

Abstract

In November, 2011, the Financial Stability Board, in collaboration with the International Monetary Fund, published a list of 29 "systemically important financial institutions" (SIFIs). This designation reflects a concern that the failure of any one of them could have dramatic negative consequences for the global economy and is based on "their size, complexity, and systemic interconnectedness". While the characteristics of "size" and "systemic interconnectedness" have been the subject of a good deal of quantitative analysis, less attention has been paid to measures of a firm's "complexity." In this paper we take on the challenges of measuring the complexity of a financial institution and to that end explore the use of the structure of an individual firm's control hierarchy as a proxy for institutional complexity. The control hierarchy is a network representation of the institution and its subsidiaries. We show that this mathematical representation (and various associated metrics) provides a consistent way to compare the complexity of firms with often very disparate business models and as such may provide the foundation for determining a SIFI designation. By quantifying the level of complexity of a firm, our approach also may prove useful should firms need to reduce their level of complexity either in response to business or regulatory needs. Using a data set containing the control hierarchies of many of the designated SIFIs, we find that in the past two years, these firms have decreased their level of complexity, perhaps in response to regulatory requirements.