Systemic risk in a very general sense is by no way a phenomenon limited to economics or the financial system. the likelihood and severity in financial systems is often regarded as considerably higher. In the area of economics it has been argued that systemic risk is a particular feature of financial systems. In the last couple of years significant concerns about the stability of national and international financial systems have been raised. The starting point of systemic risk analysis in a single-country is typically the banking system.ACADEMY OF ECONOMIC STUDIES BANKING MANAGEMENT SYSTEMS Systemic Risk In finance. and hide behind limited liability. and their highly leveraged operations. systemic risk is the risk of collapse of an entire financial system or entire market.It can be defined as "financial system instability. caused or exacerbated by idiosyncratic events or conditions in financial intermediaries". At the heart of 2 . The approach often taken at central banks and supervisory agencies is to identify systemic risks using disaggregated data. enter insolvency proceedings if a catastrophic event ever takes place. This is due to banks significant role in financial intermediation and maturity transformation. including information on the composition of banks’ asset and liabilities. maturity and currency mismatches.A full systemic crisis in the financial system may then have strong adverse consequences for the real economy and general economic welfare. Insurance is often easy to obtain against "systemic risks" because a party issuing that insurance can pocket the premiums. as opposed to risk associated with any one individual entity. 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. potentially catastrophic. issue dividends to shareholders. and other balance sheet and income metrics. group or component of a system. This kind of risk can be mitigated by hedging an investment by entering into a mirror trade. While contamination effects may also occur in other sectors of the economy. It is claimed that any such concept must integrate systemic events in banking and financial markets as well as in the related payment and settlement systems.

in particular when asymmetric information has prevented the market mechanism from doing its job ex ante. not all systemic events in financial systems need to be ineficient.  the complex network of exposures among fiancial institutions  the intertemporal character of financial contracts and related credibility problems. differentiating between potential losses on crossborder claims. a substantial portion of the financial system. although a general theoretical paradigm is still missing.ACADEMY OF ECONOMIC STUDIES BANKING MANAGEMENT SYSTEMS systemic risk are contagion effects. risk managers track Value-at-Risk (VaR). Systemic financial risk is the risk that a shock will trigger a loss of economic value or confidence in. Some financial crises might just eliminate ineficient players in the system. based on the notion that real effects is what concerns policymakers most since they are likely to entail welfare consequences. The quantitative literature on systemic risk.To control risk in financial institutions. The scenario starts from asset credit exposures. However. It then captures the propagation of shocks across borders through 3 . policy makers may wish to track measures of worst possible real macroeconomic outcomes. To control risk in the economy. VaR measures the worst possible portfolio loss over a given time horizon at a given probability.  Systemic events Systemic events typically involve a combination of self-reinforcing asset and funding shocks which then spill-over to banks in other countries. Various rigorous models of bank and payment system contagion have now been developed. Systemic real risk is the risk that a shock will trigger a significant decline in real activity. and off-balance sheet exposures. is surveyed in the light of this concept. We make a distinction between systemic real risk and systemic financial risk. various forms of external effects. affiliates’ claims. and attendant increases in uncertainty about. The concept also includes simultaneous financial instabilities following aggregate shocks. We identify three interrelated characteristics that may justify why financial systems can be more vulnerable to systemic risk than other sectors of the economy:  the structure of bank balance sheets. which was evolving swiftly in the last couple of years.

A systemic event in the narrow sense is strong. however. Similarly. shocks can be idiosyncratic or systematic. or if the market affected in later rounds also crash and would not have done so without the initial shock. if the institution affected in the second round or later actually fail as a consequence of the initial shock. funding shocks and deleveraging. shocks and propagation mechanisms.ACADEMY OF ECONOMIC STUDIES BANKING MANAGEMENT SYSTEMS bank losses. e. The key element in this definition of systemic risk.g. Again. where the release of “ bad news” about a financial institution. Following the terminology of financial theory. their failure or crash. although they have been fundamentally solvent ex ante. or the crash of a financial market leads in a sequential fashion to considerable adverse effects on one or several other financial institutions or markets. if a significant part of the financial institutions/markets simultaneously affected by them (do not) actually fail/crash. We define a systemic event in the narrow sense as an event. or even its failure. it suffers from the weaknesses of existing data. Systemic risk (in the narrow and broad sense) can then be defined as the risk of experiencing systemic events in the strong sense. is composed of two important elements itself. 4 . systemic events related to systematic shocks are strong (weak). the systemic event.

market share concentration. The impact is measure beyond the institution's products and activities to include the economic multiplier of all other commercial activities dependent specifically on that institution. this is the very core of the systemic risk concept. e. in particular potential contagion effects. (i) Traditionally.. First. This makes risk measures at the firm level a natural starting point to think about systemic risk. Systematic shocks. the "too interconnected to fail" test is a measure of the likelihood and amount of medium-term net negative impact to the larger economy of an institution's failure to be able to conduct its ongoing business. are equally important for the non-financial sectors in the economy. the "too big to fail" and the "too interconnected to fail" tests. and competitive barriers to entry or how easily a product can be substituted. Measuring systemic risk is.  The financial fragility hypothesis Why is it then that systemic risk. when the law of large 5 . (ii) the interconnection of financial institutions through direct exposures and settlement systems and (iii) the information intensity of financial contracts and related credibility problems.  Measurement of systemic risk There are two key assessments for measuring systemic risk. Normally. related to measuring firm risk. the "too big to fail" test is the traditional analysis for assessing the risk of required government intervention. The impact is also dependent on how correlated an institution's business is with other systemic risks.g. to some extent.ACADEMY OF ECONOMIC STUDIES BANKING MANAGEMENT SYSTEMS The second key element in systemic events in the narrow sense is the mechanism through which shocks propagate from one financial institution or market to the other. Systemic risk has two important elements: It builds up in the background during the runup phase of imbalances or bubbles and materializes only when the crisis erupts. a large literature has explored such firm-level risk measures.Over the last two decades. commercial banks take fixed-value deposits that can be withdrawn at very short notice and lend long term to industrial companies. In our view. Second. are of special concern in the financial system? There are thre interrelated features of financial systems that can provide a basis for this fi nancial fragility hypothesis: (i) the structure of banks. The "too big to fail" can be measured in terms of an institution's size relative to the national and international marketplace.

a crisis situation can trigger difficulties in the technical completion of the different steps of the payment and settlement process. However. such as insurance companies. as is now more often the case. Notice that this “ special” character of banks does not apply to most other financial intermediaries. Moreover. In fact. Financial decisions aim at the intertemporal allocation of purchasing power for consumption and are. when exceptionally high withdrawals occur and long term loans cannot be liquidated. banks tend to play a key role in wholesale and retail payment and settlement systems. 6 . the information and control intensity of financial contracts. Even worse. At certain points during the business day. most importantly. these exposures can be very large. (iii) The third feature is. This fractional reserve holding can lead to illiquidity and even default. So. based on expectations on what the value of the respective asset is going to be in the future or whether the future cash flows promised in a financial contract are going to be met. single bank loans do not have an objective market price.Various risk management measures are usually applied to limit the potential of contagion in payment and settlement systems. only a small fraction of assets needs to be held in liquid reserves to meet deposit withdrawals. therefore.ACADEMY OF ECONOMIC STUDIES BANKING MANAGEMENT SYSTEMS numbers applies. securities houses and the like. although the bank might be fundamentally solvent in the long run. more generally. These three features taken together seem to be the principal sources for the occasionally higher vulnerability of financial systems to systemic risk than other sectors of the economy. the large-value payment and security settlement systems. the health of a bank not only depends on its success in picking profitable investment projects for lending but also on the confidence of depositors in the value of the loan book and. if banks and other intermediaries belong to the same financial entity. so that the failure of one bank to meet payment obligations can have an immediate impact on the ability of other banks to meet their own payment obligations. in their confidence that other depositors will not run the bank. which would amplify effective exposures and domino effects. nonbank intermediaries problems might still become a source of bank fragility. (ii) There is a complex network of exposures among banks through the interbank money market.

individually rational bank management may lead to a higher level of systemic risk than would be socially optimal. Another element of the safety net and of crisis management that has been widely debated is emergency liquidity assistance by the central bank to individual financial institutions in distress. a systemic crisis affecting a large number of financial institutions or markets can . Notice that in this sense. If contagion is very strong. a first assessment to which extent systemic risk is relevant for economic and Þ nancial policies can be undertaken. They do not go they contagious or not . the private costs of the initial failure can be lower than the social costs. In particular. In fact. 7 . theoretical models explicitly focussing on securities market contagion are extremely scarce. Strong systemic events. This contrasts with the existence of some theories of systemic risk in banking markets and some practical studies of systemic risk in payment and settlement systems. credit risk (failure of an insolvent participant with a subsequent loss of principal).  Systemic risk and financial markets The role of financial markets is perhaps the most difficult element in the analysis of systemic risk. the default of which may trigger contagion effects. the socially optimal probability of bank failures is not zero. liquidity risk. As a consequence. such as contagious failures.impose on the rest of the financial sector and the real economy.ACADEMY OF ECONOMIC STUDIES BANKING MANAGEMENT SYSTEMS  Systemic risk and public policy On the basis of the conceptual considerations presented so far. but tend to recover after some time.  Systemic risk in payment and settlement systems The fundamental underlying risks in these systems are similar to those encountered by financial institutions in general: operational risk. as single institutions can. By providing the technical infrastructure through which banking and securities market transactions are settled. While there can be price crashes/liquidity shortages and propagation of them from one market to the other. may involve external effects. the main concern will be with the shocks that financial market crashes and temporary liquidity crises . Second. markets are different from financial corporations. then the microeconomic risk allocation problem can degenerate to a macroeconomic destabilisation. payment and settlement systems determine to an important extent the physical exposures among financial institutions.via a "credit crunch" or "debt deflation"lead to a recession or even to a depression.

ACADEMY OF ECONOMIC STUDIES BANKING MANAGEMENT SYSTEMS Conclusions In a broad sense the concept also includes wide systematic shocks which by themselves adversely affect many institutions or markets at the same time. we discussed the various elements of systemic risk with a view to first develop a broad concept of this risk. in stark contrast. 8 . The recent financial crisis has rekindled interest in the relationship between the structure of the financial network and systemic risk. as it facilitates the spread of financial distress and solvency problems from one bank to the rest in an epidemic-like fashion. In conclusion. Two polar views on this relationship have been suggested in the academic literature and the policy world. as individual banks are overly exposed to the liabilities of a handful of financial institutions. hypothesizes that it is the highly interconnected nature of the financial system that contributes to its fragility. The first maintains that the “incompleteness” of the financial network can be a source of instability. which is underlying the understanding of financial crises. In this sense. systemic risk goes much beyond the vulnerability of single banks to runs in a fractional reserve system. and that can be used as a baseline for financial and monetary policies to maintain stable financial systems. The second view.

2012 : Systemic risk in global banking: What available data can tell us and what more date are needed?  Daron Acemoglu. financial crises and systemic risk  Eugenio Cerutti. Philipp Hartmann. 2011: Systemic risks amd the macroeconomy  Markus K. Patrick McGuire. Stijn Claessens. Alireza Tahbaz-Salehi.ACADEMY OF ECONOMIC STUDIES BANKING MANAGEMENT SYSTEMS BIBLIOGRAPHY  Oliver de Bandt. 2012: Bubbles. 2010 : Systemic risk: a survey  Gianni De Nicolò . Asuman Ozdaglar.2013: Systemic risk and stability in financial networks  PCI Definition of Systemic Risk 9 .Marcella Lucchetta. Martin Oehmke. Brunnermeier.