Financial System Architecture and Technological Vulnerability

Selman Erol and Michael Lee

No 1122, Staff Reports from Federal Reserve Bank of New York

Abstract: This paper presents a framework to study of technological resiliency of financial system architecture. Financial market infrastructures, or platforms, compete with services critical functions along various stages in the lifecycle of a trade, and make investments in technological resiliency to guard against attackers seeking to exploit system weaknesses. Platforms’ financial network effects attenuate competition between platforms on security. Exposure to vulnerabilities is magnified in the presence of strategic adversaries. Private provision of technological resiliency is generally sub-optimal, with over- and underinvestment in security depending on market structure. Vulnerabilities evolve over the maturity of a financial system, but there generically exists a tipping point at which technological resiliency diverges from optimal and creates technological drag on the financial system. We find supportive evidence in tri-party repo settlement: the exit of duopolist resulted in a significant drop in IT-related investment by the sole provider, even as peer firms ramp up investment.

Keywords: financial market architecture; technological vulnerability; cyber risk; financial stability (search for similar items in EconPapers)
JEL-codes: D47 D82 D86 G29 (search for similar items in EconPapers)
Pages: 45
Date: 2024-09-01
New Economics Papers: this item is included in nep-pay
Note: Revised October 2024.
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DOI: 10.59576/sr.1122

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