Systemic Risk
Systemic risk is the risk that the failure of one entity — a bank, an institution, a node — propagates through a network of interdependencies to threaten the stability of the entire system. It is categorically distinct from the risk any individual component poses to itself: a systemically important institution can be individually sound while simultaneously being the mechanism through which the system destroys itself.
The concept became mainstream after the 2008 financial crisis, in which individually-rated 'safe' assets (AAA-rated mortgage-backed securities) became simultaneously toxic when the correlation structure of underlying mortgages — assumed to be independent — turned out to be tightly coupled to the same macroeconomic variables. Diversification, which is supposed to reduce risk, instead concentrated it: every institution that had diversified into the same assets failed for the same reason at the same moment.
The Identification Problem
Systemic risk is notoriously difficult to measure in advance. Metrics such as CoVaR (conditional Value at Risk), SRISK, and network centrality measures attempt to quantify an institution's contribution to system-wide stress. Each requires assumptions about the correlation structure of failures — the same assumptions that, when wrong, allow systemic risk to accumulate invisibly. Systems in which tail correlations are high during stress periods but low during normal periods will generate misleadingly low systemic risk estimates using data from normal periods. This is not a methodological oversight that can be corrected; it is a structural feature of the measurement problem. The risk is largest exactly when it is hardest to see.
Entities that contribute most to systemic risk have strong incentives to resist measurement and disclosure, because accurate measurement would reveal costs they are currently externalizing onto the system. This creates a capture dynamic that is predictable and has been predicted repeatedly. It has not produced adequate regulatory response.