Systemic Risk

CORE DEFINITION

Systemic risk is the risk that the failure of an individual component or participant spreads through the linkages of a system and disrupts its overall function, as opposed to risk confined to that component. Its core proposition is that interconnectedness and leverage are the main transmission channels, so losses that would be containable in isolation become nonlinear and system-wide once they travel through the network. The key qualification is that systemic risk cannot be eliminated by diversification, because diversification reduces idiosyncratic exposure while leaving shared exposures untouched; it requires capital buffers, liquidity, and circuit breakers, and it must be assessed through stress scenarios rather than single-firm measures.