CandleFocus Glossary Editor
Systemic risk, often referred to as systematic risk, is the potential and possibility of an event in the financial system that could potentially cause a large and widespread financial collapse impacting the global economy. Such an event could be a single event, such as the failure of a large bank, or an accumulation of events that eventually lead to a larger catastrophe.
Systemic risk results from the interconnectedness of financial institutions, markets, and transactions in the global marketplace. When one entity experiences distress, it can cause a ripple effect that is felt across the entire financial system. These effects can be particularly profound when the troubled entity is too large for another firm to absorb.
The 2008 global financial crisis is an example of systemic risk, resulting from the accumulation of events such as the failure of major financial institutions, market crashes, and problems with mortgage-backed securities. This had an enormous impact on financial markets around the world and was a major contributor to the global recession.
Financial regulators have increasingly put measures in place to help mitigate systemic risk and to reduce a system’s vulnerability to shocks. This includes stress tests, higher capital requirements, and liquidity regulations. Regulators are now more focused on understanding systemic risk and how it can be minimized.
In addition to further regulation, many financial institutions are now looking at alternative methods of managing systemic risk. These include using models to identify interlinkages between firms, utilizing stress tests, better understanding asset prices and valuations, increasing transparency, and establishing effective resolution regimes.
Systemic risk can also manifest itself in other ways, such as operational risk, cyber risk, and geopolitical risk. As such, financial institutions must include risk management techniques that can address these other sources of risk, in addition to systemic risk.
Despite all the safety measures, systemic risk is still an ever-present threat in the financial system. It remains a key concern of policymakers, as they work to ensure there is a strong regulatory foundation in place to reduce the risk of a financial collapse and safeguard the global economy.
Systemic risk results from the interconnectedness of financial institutions, markets, and transactions in the global marketplace. When one entity experiences distress, it can cause a ripple effect that is felt across the entire financial system. These effects can be particularly profound when the troubled entity is too large for another firm to absorb.
The 2008 global financial crisis is an example of systemic risk, resulting from the accumulation of events such as the failure of major financial institutions, market crashes, and problems with mortgage-backed securities. This had an enormous impact on financial markets around the world and was a major contributor to the global recession.
Financial regulators have increasingly put measures in place to help mitigate systemic risk and to reduce a system’s vulnerability to shocks. This includes stress tests, higher capital requirements, and liquidity regulations. Regulators are now more focused on understanding systemic risk and how it can be minimized.
In addition to further regulation, many financial institutions are now looking at alternative methods of managing systemic risk. These include using models to identify interlinkages between firms, utilizing stress tests, better understanding asset prices and valuations, increasing transparency, and establishing effective resolution regimes.
Systemic risk can also manifest itself in other ways, such as operational risk, cyber risk, and geopolitical risk. As such, financial institutions must include risk management techniques that can address these other sources of risk, in addition to systemic risk.
Despite all the safety measures, systemic risk is still an ever-present threat in the financial system. It remains a key concern of policymakers, as they work to ensure there is a strong regulatory foundation in place to reduce the risk of a financial collapse and safeguard the global economy.