Systemic Risk

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Description of Systemic Risk. Explanation.


Cascading Failure: Systemic RiskDefinition Systemic Risk. Description.

Systemic Risk is the risk inherent to the entire market or an entire financial system.

In other words it is the risk of collapse of an entire financial system or of the entire market, as opposed to risk associated with any one individual entity, group or component of a system.

It involves all forms of widespread risk that are not particular to a company and which affect all companies or the entire financial system as a whole. Examples include a stock market crash, the breakdown of the entire banking system or the event of a nuclear war.

It refers to the risks imposed by interlinkages and interdependencies in a system or market, where the failure of a single entity or cluster of entities can cause a Cascading Failure, which could potentially bankrupt or bring down the entire system or market.

There are two key assessments for measuring systemic risk, the "too big to fail" (TBTF) and the "too interconnected to fail" (TICTF) tests:

  • Too Big To Fail: TBTF can be measured in terms of an institution's size relative to the national and international marketplace, market share concentration, and competitive barriers to entry or how easily a product can be substituted.
  • Too Interconnected to Fail: TICTF is a measure of the likelihood and amount of medium-term net negative impact to the larger economy of an institution's failure to be able to conduct its ongoing business. The impact is measured not just on the institution's products and activities, but also the economic multiplier of all other commercial activities dependent specifically on that institution.

Investors can not protect their investments from this type of risk by diversifying their portfolio.

Sometimes also called: Market Risk.

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Compare with: Non-Systemic Risk  |  Efficient Market Hypothesis  |  Behavioral Finance  |  Capital Asset Pricing Model  |  Plausibility Theory  |  Hedge  |  Hedging  |  Organizational Resilience

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