2023-05-12 08:18:00
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The recent turmoil in the banking sector, in particular with the failure of Silicon Valley Bank (SVB) and Signature Bank, the collapse of Credit Suisse and its takeover by UBS, as well as the uncertainties around Deutsche Bank, have resurrected the risk of systemic crisis comparable to the financial and economic crisis observed in 2007/2008.
In this article, let’s return to the notion of systemic risk in finance, how it can impact the decisions of different economic agents, as well as how to protect once morest it.
Systemic risk: definition
Systemic risk in finance corresponds to a risk that the disturbances and turbulence observed in one part of a financial system might quickly spread to other parts or other establishments of the said financial system, ultimately impacting the financial system in a widespread, then the economy as a whole.
Systemic risk is a risk inherent in the global financial system, which is often due to the concentration of risks and the interconnectedness of today’s economies, can be caused by different endogenous or exogenous factors such as a bank run, disasters events, scandals, political crises or even wars.
Systemic risk: example
The most recent and striking example of this situation is the housing loan crash in the United States in 2008 (subprime mortgage crisis). This real estate crisis quickly spread to the local and global economic and financial system.
Bank failures, massive layoffs, public panic over the security of bank deposits, difficulties in obtaining cash or lines of credit between financial institutions, stock market crashes and others have affected all sectors of activity, leading to a global economic crisis.
Systemic risk and consequences on the behavior of economic agents
The sudden deterioration in financial stability or overall financial conditions, often leading to systemic risk, is usually due to a bank run in which the behavior of economic agents plays a key role.
The perceived risk leads to rational behavior which nevertheless accelerates the imbalances and leads to a rapid degeneration of the situation: customers tend to withdraw their money massively in a very short time before it is too late and they lose All.
Financial institutions then find themselves in delicate situations if they have not anticipated enough and they do not have enough liquidity to meet the strong and sudden demand for cash.
The drying up of liquidity may affect the interbank market because of the significant interconnection existing in this sector between the various players and markets. The chain reactions of negative effects on other sectors of activity can lead to a general crisis and have serious consequences on an economy.
Systemic risk: how to guard once morest it?
After each major global crisis, governments, central banks and regulators strengthen monitoring mechanisms and regulations to avoid systemic risk in finance as much as possible and to be able to better detect it. In addition, they have also put in place resolution mechanisms for better management of financial crises and better prevention of systemic risk.
Since the financial crisis of 2007/2008, for example, many regulations have been put in place, whether they concern the banking sector, the financial markets or financial products, to require concrete actions from financial institutions so that this situation does not happen once more.
The aim is thus to obtain better financial stability and to ensure that certain risk management practices are adopted and applied (greater transparency of activities and financial products, better sharing of information, strengthening of capital, etc.).
As an investor, it is difficult to anticipate systemic risk and protect once morest it. However, there are some good practices that you can put in place such as diversifying your investment portfolio.
Avoid focusing on a single company, a specific sector or a particular country by investing in several industries that are not necessarily correlated.
Also consider exposing yourself to countries and economies other than your own. By investing in international markets, you can take advantage of different opportunities depending on the economic cycle and growth prospects of the country in question. In addition, in the event of a systemic crisis, countries may be affected differently, which might better protect you in certain cases. With foreign markets, you can also invest in different currencies.
You can also add different asset classes to your portfolio to better diversify the risk of your investments. Gold, for example, is a precious metal particularly appreciated for its safe haven side in the event of a crisis or uncertainties regarding the overall economic health.
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