Learn the Difference Systemic vs. Systematic Risk

Learn the Difference Systemic vs. Systematic Risk

Systemic vs. Systematic Risk: An Overview

Systemic risk describes an event that can spark a major collapse in a specific industry or the broader economy. Systematic risk is the pervasive, far-reaching, perpetual market risk that reflects a variety of troubling factors.

Systemic risk is often a complete, exogenous shock to the system, such as the threat that one of the major banks that collapsed during the 2008 financial crisis could then trigger a massive market implosion. Systematic risk is the overall, day-to-day, ongoing risk that can be caused by a combination of factors including the economy, interest rates, geopolitical issues, corporate health, and other factors. Systemic risk is harder to quantify and harder to predict, whereas a systematic risk is more quantifiable and can be anticipated, in some cases.

Systemic Risk

Systemic Risk represents the risk connected to the complete failure of a business, a sector or industry, a financial institution or the overall economy. It can also be used to describe small, specific problems, such as security flaws for bank account, or web user information. Bigger, wider-reaching issues include a broad economic crisis sparked by a collapse in the financial system.

The word systemic, itself, is mainly used to describe a specific health-related issue that affects a person’s entire body. This description has then been borrowed to explain the way smaller financial issues can dangerously import the economy or financial system.

System risk is a danger caused by an occurrence at the local or company level that is substantive enough to impact the broader financial system.

Systematic Risk

While systemic risk is a bit amorphous, systematic risk has a more common meaning. The term is often used interchangeably with “market risk” and means the danger that is baked into the overall market that can’t be resolved by diversifying your portfolio or holdings. Broad market risk can be caused by recessions or periods of economic weakness, wars, rising or stagnating interest rates, fluctuations in currencies or commodity prices, among other big-picture issues. While systematic risk can’t be knocked out with a different asset allocation strategy, it can be managed.

The market risk that is firm or industry-specific and is fixable is called unsystematic or idiosyncratic risk. With Systematic risk, diversification won’t help, because the risks are much broader than one sector or company. The word systematic implies a planned, step-by-step approach to a problem or issue.

Investors hoping to mitigate the risks of systematic risk can make sure that their portfolios include a variety of asset classes, such as equities, fixed income, cash, and real estate, as each of these will react differently to a major systemic change.

Systemic vs. Systematic Risk Example

One recent example of systemic risk is the collapse of Lehman Brothers in 2008, which sent shockwaves throughout the financial system and the economy. Because Lehman Brothers was a large company, deeply ingrained in the economy, its collapse resulted in a domino effect that generated a major risk to the global financial system, necessitating government intervention.

The Great Recession” of the late 2000s is an example of systematic risk. Anyone who was invested in the market in 2008 saw the values of their investments change drastically from this economic event. This recession affected asset classes in different ways as riskier securities were sold off in large quantities, while simpler assets, such as U.S. Treasury securities increased their value.

Key Takeaways

  • Systemic risk and systematic risk are both dangers to the financial markets and economy, but the cause of and management of each is different.
  • Systemic risk is the risk that an event at the company or industry level could trigger a huge collapse, like the 2008 financial crisis.
  • Systematic risk is the risk inherent to the entire market, attributable to a mix of factors economic, socio-political and market-related.

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