Systemic Risk
The risk of collapse across an entire financial system due to interconnected institutions and cascading failures.
What is Systemic Risk?
Systemic risk is the risk that the failure of one institution, market, or segment of the financial system triggers a cascade of failures across the broader economy — not merely isolated losses. It arises from interconnectedness: if a major bank defaults on contracts with counterparties who depend on those payments to meet their own obligations, the shock propagates through the network. Systemic risk is distinct from the idiosyncratic risk of an individual company failing. It cannot be eliminated through portfolio diversification — it is the risk that the entire system fails simultaneously. Post-2008 financial regulation (Dodd-Frank, Basel III) focused heavily on identifying and mitigating systemic risk through stress testing, capital buffers, and resolution planning.
Example
The 2008 financial crisis demonstrated systemic risk on a global scale. The collapse of subprime mortgage values triggered losses at leveraged institutions globally, froze short-term credit markets (LIBOR spreads spiked), caused stock markets to fall 50%, and led to the deepest recession since the Great Depression — all originating from a localized US housing market decline. The interconnectedness of mortgage-backed securities, derivatives, and interbank lending transformed a sectoral problem into a global systemic event.