Financial Stability under Stress: The Transmission of Systemic Risk and the Institutional Foundations of Resilience in Modern Financial Systems

This paper examines the relationship between financial crises, systemic risk and the resilience of financial institutions by bringing together recent contributions on systemic-risk measurement, financial networks, bank capitalization, liquidity, governance, macroprudential regulation and nonbank financial intermediation. The literature shows that financial instability cannot be understood solely through the probability of failure of individual institutions. Systemic vulnerability arises from interactions among leverage, capital shortages, interconnected exposures, common asset holdings, funding structures and market-liquidity conditions. The evidence also indicates that institutional resilience depends strongly on ex-ante balance-sheet strength, including capital and liquidity buffers, as well as on governance arrangements and the regulatory environment. The COVID-19 crisis provides an important stress episode showing that stronger post-global-financial-crisis regulation improved banks’ ability to absorb an external shock while preserving part of their lending function. Nevertheless, vulnerabilities increasingly extend beyond traditional banking toward investment funds, shadow banking and market-based intermediation. The paper consequently emphasizes a system-wide conception of resilience combining institution-level soundness, macroprudential supervision, stress testing and monitoring of interconnected financial markets. Differences across conventional and Islamic banking models further demonstrate that resilience is conditioned by institutional architecture and the broader economic environment.