Systemic risk denotes all those risks that are faced by the entire market and not limited to any single individual or business. These risks are unavoidable because the entire market collapse at the same time. Because of this, a portfolio created with assets of various natures is also not enough to prevent such risks. Another term used for systemic risk is market risk.
The sources of systemic risks are fluctuations in the interest rates, wars and many more. All these sources affect the entire market simultaneously. The systemic risks influence a wide range of securities product. Though systemic risks cannot be prevented, the influence of these risks can be minimized through diversification.
There are a number of examples of the systemic risk like the breakdown of several stock exchanges of the world at different times or failure of the banking system in many countries and so on.
Systemic risks related to banking sector are hedged through several processes. One such process is securitisation that denotes the process of offering credit risk derivatives. At the same time, the banks keep good amount of capital in their hands to protect themselves against any kind of market risk or credit risk. On the other hand, there are several other sectors like insurance where hedging systemic risks or arrangement for any kind of financial protection is quite hard. This is because there are several counter-parties who are not able to bear the systemic risk.
At the same time, there are several other factors that are also related to systemic risk or can maximize the influence of systemic risk. The potential breakability of several financial markets is very important while planning the ways of hedging the systemic risks and the losses caused by that. There are several participants in such fragile markets who are involved in trading beyond their capital resources. Now, in such situations, if one trader comes out as unsuccessful the other traders are also exposed to systemic risks.
Last Updated on : 1st July 2013