Systemic Risk


DEFINITION of 'Systemic Risk'

The possibility that an event at the company level could trigger severe instability or collapse an entire industry or economy. Systemic risk was a major contributor to the financial crisis of 2008. Companies considered a systemic risk are called “too big to fail.” These institutions are very large relative to their respective industries or make up a significant part of the overall economy. A company that is highly interconnected with others is also a source of systemic risk. Systemic risk should not be confused with systematic risk.

BREAKING DOWN 'Systemic Risk'

Federal government uses systemic risk as a justification to intervene in the economy. The basis for this intervention is the belief that the federal government can reduce or minimize the ripple effect from a company-level event through targeted regulations and actions. For example, the Dodd-Frank Act of 2010, an enormous set of new laws, is supposed to prevent another Great Recession from occurring by tightly regulating key financial institutions to limit systemic risk.

Lehman Brothers’ size and integration into the U.S. economy made it a source of systemic risk. When the firm collapsed, this event created problems throughout the financial system and the economy. Capital markets froze up while businesses and consumers couldn’t get loans, or could only get loans if they were extremely creditworthy, posing minimal risk to the lender.

Simultaneously, AIG was also suffering serious financial problems. Like Lehman, AIG’s interconnectedness with other financial institutions made it a source of systemic risk during the financial crisis. AIG’s portfolio of assets tied to subprime mortgages and its participation in the residential mortgage-backed securities market through its securities-lending program led to collateral calls, a loss of liquidity and a downgrade of AIG’s credit rating when the value of those securities dropped. While the U.S. government did not bail out Lehman, it decided to bail out AIG with loans of more than $180 billion, preventing the company from going bankrupt. Analysts and regulators believed that an AIG bankruptcy would cause numerous other financial institutions to collapse as well.


  1. Ulcer Index - UI

    An indicator developed by Peter G. Martin and Byron B. McCann ...
  2. Risk-On Risk-Off

    An investment setting in which price behavior responds to, and ...
  3. Risk Seeking

    The search for greater volatility and uncertainty in investments ...
  4. State Street Investor Confidence ...

    An index that measures investor confidence by looking at actual ...
  5. Regret Theory

    A theory that says people anticipate regret if they make a wrong ...
  6. Risk Tolerance

    The degree of variability in investment returns that an individual ...
Related Articles
  1. Investing Basics

    Tops Tips for Trading ETFs

    A look at two different trading strategies for ETFs - one for investors and the other for active traders.
  2. Mutual Funds & ETFs

    The Basics of How Mutual Funds Are Rated

    Learn how the major rating agencies assign mutual fund ratings. Understand what these ratings measure and how they are different from each other.
  3. Retirement

    How Much Can You Contribute to Your 401(k)?

    Given the fairly high compensation limits on these retirement plans, most workers can pitch in more than they currently do.
  4. Economics

    Looking to Invest In Ukraine? Here is How

    We examine a number of ways to invest in Ukraine, including ETFs, managed funds, corporate investments, and Eurobonds.
  5. Budgeting

    Retirement Tips for Millennials from Gen Xers

    Gen Xers' financial situation has been very different from previous generations'. Now they'd like to pass on some hard-earned wisdom to the Millennials.
  6. Mutual Funds & ETFs

    Top 4 Inverse Equities ETFs

    Explore analysis of some of the most popular inverse and leveraged-inverse ETFs that track equity indexes, and learn about the suitability of these ETFs.
  7. Investing

    Yellow Light Trade Risk Management

    Being in the stock market for so long I tend to look at the world through the eyes of a trader, but how to decide when we are presented with two options?
  8. Retirement

    How Much It Takes to Max Out Your IRA

    IRAs have certain tax advantages that allow your nest egg to grow at a faster rate. But there are annual limits on how much you can contribute.
  9. Retirement

    The Backdoor Way to Qualify for a Roth IRA

    Meet with your tax advisor to find out what a backdoor Roth IRA is. Basically, it's a tax loophole that could help you prepare for retirement.
  10. Professionals

    Turbulent Market? Affluent Clients Need Help, Too

    Many wealthy clients aren't so confident with investments during volatile markets, according to a recent study. That means opportunity for advisors.
  1. Do mutual funds invest only in stocks?

    Mutual funds invest in stocks, but certain types also invest in government and corporate bonds. Stocks are subject to the ... Read Full Answer >>
  2. Can you buy penny stocks in an IRA?

    It is possible to trade penny stocks through an individual retirement accounts, or IRA. However, penny stocks are generally ... Read Full Answer >>
  3. What percentage of a diversified portfolio should large cap stocks comprise?

    The percentage of a diversified investment portfolio that should consist of large-cap stocks depends on an individual investor's ... Read Full Answer >>
  4. How attractive is the food and beverage sector for a growth investor?

    The food and beverage sector is attractive for a growth investor. The sector's high degree of volatility means it tends to ... Read Full Answer >>
  5. How attractive is the retail sector for a growth investor?

    Retail is an attractive sector for a growth investor due to its propensity for turning in bigger-than-average gains when ... Read Full Answer >>
  6. What sectors have higher exposure to inherent risk?

    Sectors with complex accounting requirements, such as financial services, banking, energy and utilities, have high inherent ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Zero-Sum Game

    A situation in which one person’s gain is equivalent to another’s loss, so that the net change in wealth or benefit is zero. ...
  2. Capitalization Rate

    The rate of return on a real estate investment property based on the income that the property is expected to generate.
  3. Gross Profit

    A company's total revenue (equivalent to total sales) minus the cost of goods sold. Gross profit is the profit a company ...
  4. Revenue

    The amount of money that a company actually receives during a specific period, including discounts and deductions for returned ...
  5. Normal Profit

    An economic condition occurring when the difference between a firm’s total revenue and total cost is equal to zero.
  6. Operating Cost

    Expenses associated with the maintenance and administration of a business on a day-to-day basis.
Trading Center
You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!