What is systemic risk?

Systemic risk is the probability that a financial system, an industry or an economy will collapse due to one of its components. The key to understanding its scope is interdependence: the greater the link between components, the greater the risk that the failure in one of them will spread to the others, generating a chain reaction. Just as in the human body, a condition in one organ can affect others, or a blood problem can affect everyone, a failure in a bank or in the banking system as a whole can drag down the economic sectors that depend on them. Faced with the uncertainty involved, governments and international organizations have carried out efforts to predict and mitigate systemic risk, especially since the crisis in 2008.

Systemic or systematic risk?

Systemic risk should not be confused with the more general and identifiable systematic risk. Also known as market risk, it is the risk that the market itself carries, but due to external factors, such as the political situation. Unlike systemic risk, where an unforeseen fall of one entity can collapse an entire sector, systematic risk is always present due to the uncertainty that the market itself carries. Furthermore, it usually affects all sectors of the economy to different extents, while the scope of systemic risk is determined by the interrelationship between sectors. That is why it is considered more difficult to anticipate, both to determine if it will arise and to estimate its scope.

A systemic risk in a financial sector, in turn, can be part of a systematic risk. An example was the fall of Lehman Brothers in 2008. The integration of the until then fourth largest investment bank in the United States into the country’s economy meant that its fall had repercussions throughout the capital market, causing the fall of other financial entities. . Merrill Lynch and Bear Stearns, among others, had to be acquired, while the insurer AIG was rescued by the US Federal Reserve. The fall of Lehman Brothers is related to systematic risks such as the real estate bubble and the subsequent financial crisis, but what makes the example a systemic risk is its sudden fall and its repercussions on the financial markets themselves.

The intervention cures, but does not eradicate

Since the global financial crisis of 2008, both governments and international organizations have taken a more active role to mitigate systemic risks. For example, after the effects of the fall of Lehman Brothers, the United States Government decided to rescue companies considered too big to fail (‘too big to fail’), that is, those financial entities whose failure would be capable of collapsing the financial system. One of them was AIG, with loans of up to $180 billion.

Regulatory frameworks and specialized groups have also been established to anticipate systemic risks. In the United States, the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010 aims to prevent the risky behavior that led to the crisis, and focuses on key entities for the financial system. That same year, the European Union created the European Systemic Risk Board (ESRB) to prevent and mitigate the phenomenon. Likewise, indicators have emerged to measure characteristics that indicate a possible systemic event. An example is the European SRISK, which measures the strength and capacity of banking entities to face a hypothetical crisis. However, although all these prevention measures allow for a better response, they do not prevent new systemic risks from existing due to progress in the behavior of the economy.