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Financial System Architecture and Technological Vulnerability

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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.

Suggested Citation

  • Selman Erol & Michael Junho Lee, 2024. "Financial System Architecture and Technological Vulnerability," Staff Reports 1122, Federal Reserve Bank of New York.
    • Handle: RePEc:fip:fednsr:98922
    DOI: 10.59576/sr.1122
    Note: Revised October 2024.
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    More about this item

    Keywords

    financial market architecture; technological vulnerability; cyber risk; financial stability;
    All these keywords.

    JEL classification:

    • D47 - Microeconomics - - Market Structure, Pricing, and Design - - - Market Design
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G29 - Financial Economics - - Financial Institutions and Services - - - Other

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