Systemic Risk and Systemic Risk: An Overview
Systemic risk describes events that could trigger a major collapse in a particular industry or the wider economy. Systemic risk is a pervasive, far-reaching, permanent market risk that reflects a variety of troubling factors.
Systemic risk is usually a completely exogenous shock to the system, such as the threat that the failure of one of the major banks during the 2008 financial crisis could trigger a massive market implosion.
Systemic risk is an overall, day-to-day, ongoing risk arising from a combination of factors including the economy, interest rates, geopolitical issues, business health and other factors.
- Both systemic risk and systemic risk are dangerous to financial markets and the economy, but the reasons for these risks—and the ways to manage them—are different.
- Systemic risk is the risk that a company- or industry-level risk could trigger a massive collapse.
- Systemic risk is a risk inherent in the overall market and can be attributed to a variety of factors including economic, socio-political and market-related events.
Systemic risk is more difficult to quantify and predict, while systemic risk is more quantifiable and predictable (in some cases).
Systemic risk represents the risk associated with the complete failure of a business, sector, industry, financial institution, or the economy as a whole. It can also be used to describe small, specific issues, such as security breaches in bank accounts or website user information. The larger, broader issue includes a broader economic crisis triggered by the collapse of the financial system.
The term system itself is mostly used to describe a specific health-related problem that affects a person’s entire body. Then borrow this description to explain how smaller financial problems can dangerously affect the economy or financial system.
While systemic risk is somewhat uncertain, systemic risk has a more general meaning. The term is often used interchangeably with “market risk” and refers to the risk of being integrated into the overall market that cannot be addressed by diversifying a portfolio or holding a stock. Broad market risks can arise from recessions, periods of economic weakness, wars, rising or stagnant interest rates, currency or commodity price fluctuations, and other significant issues. While systemic risk cannot be eliminated through different asset allocation strategies, it can be managed.
Fixed or industry-specific and repairable market risk is called unsystematic or heterogeneous risk. For systemic risk, diversification will not help. This is because the risks are much more than one sector or company. The term system means a planned, step-by-step approach to a problem or problem.
Investors looking to mitigate systemic risk exposure can ensure that their portfolio includes a variety of asset classes — such as equities, fixed income, cash and real estate — as each will respond differently to major systemic changes.
Systematic Risk and Systemic Risk Examples
The collapse of Lehman Brothers Holdings in 2008 is an example of systemic risk. The shockwaves were felt across the financial system and the economy after the global financial services company filed for bankruptcy. Since Lehman Brothers was a large corporation, deeply entrenched in the economy, its collapse caused a domino effect that created significant risks to the global financial system.
The Great Recession of the late 2000s is an example of systemic risk. Anyone who invested in the market in 2008 saw the value of their investment change dramatically during this economic event. The recession has affected asset classes in different ways: Riskier securities have sold off heavily, while simpler assets such as U.S. Treasuries have appreciated.