A type of risk that represents the probability of a failure of the entire banking system rather than a breakdown of individual institutions (banks). This risk is caused by a cascading failure in the financial sector (very much similar to the chain effect) due to the interdependencies within the banking or financial industry.

It reflects the probability that cumulative losses will arise from an event that triggers a series of successive losses related to a number of systemically important financial institutions in the system. The successive losses impact the system in a fashion of pervasive chain effect. The trigger event leads to a cascade of shocks and instability affecting other financial institutions, and could escalate into an all-out financial shock.

Systemic risk may also develop in to an economic shock that induces a great amount of volatility in asset prices, significant lack of liquidity in the market, potential bankruptcies and closures, etc. It also reflects a significant default risk by one market participant that exposes other participants to this risk due to the interconnections in, and between, financial institutions.