What is Systemic Risk?
Quick Answer: Systemic risk is the danger that stress at a single institution or market will cascade across the financial system, sparking liquidity crises and extreme FX volatility.
Understanding Systemic Risk
Systemic risk is the threat that failure of a major institution or market segment will trigger cascading losses across the financial system. In FX, systemic episodes—like the Global Financial Crisis or the Eurozone debt scare—cause extreme volatility and liquidity shocks.
Sources of Systemic Shocks
Leverage, interconnected balance sheets, and maturity mismatches amplify stress. Banking crises, sovereign defaults, or major broker failures can quickly spread through funding markets and derivatives positioning.
Early Warning Indicators
Monitor interbank lending spreads (e.g., LIBOR/OIS), cross-currency basis swaps, and central bank liquidity operations. Widening spreads or emergency lending often hint at growing systemic strain.
Trading Playbook
During systemic risk events, correlations converge and safe havens dominate. Reduce leverage, widen stops, or temporarily shift to capital-preservation strategies. Use cleared venues and diversified brokers to mitigate counterparty exposure.
Counterparty Exposure
Broker outages or margin calls can occur when liquidity evaporates. Maintain redundant accounts and monitor broker capitalization to survive systemic storms.
Related Terms
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