Introduction
In finance, systemic risk is the risk of collapse
of an entire financial system or entire market, as opposed to risk associated
with any one individual entity, group or component of a system. It can be defined as "financial system instability, potentially
catastrophic, caused or exacerbated by idiosyncratic events or conditions in
financial intermediaries" 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. It is also sometimes erroneously referred to as "systematic risk".
Systemic risk has been compared to a bank run which has a cascading
effect on other banks which are owed money by the first bank in trouble,
causing a cascading failure. As depositors sense the ripple effects of default,
and liquidity concerns
cascade through money markets, a panic can spread through a market, with a
sudden flight to quality, creating many sellers but few buyers for illiquid
assets. These interlinkages and the potential "clustering" of bank runs are the issues which policy
makers consider when addressing the issue of protecting a system against
systemic risk.[1]
Systemic risk should not be confused
with market or price risk as the latter is specific to the item being bought or
sold and the effects of market risk are isolated to the entities dealing in
that specific item. This kind of risk can be mitigated by hedging an investment
by entering into a mirror trade.[2]
