PROFESSOR: Now that you have seen the risks that

apply to individual financial institutions

or stand-alone risks, let's now turn to the concept
of systemic risk.
It's usually a good idea to start with a definition.
What do we mean by systemic risk?
Several oversight bodies and academicians
have come up with some definitions.
All of them have two common components
which are highlighted--
first, that risks arise for the financial system as a whole,
meaning the risks affect multiple financial institutions
or markets at the same time or are interrelated in some way.
For instance, banks often lend their excess checking account
deposits, those they can't use immediately,
to other banks for short-term needs.
If several banks suffered an unexpectedly high withdrawal
of deposits and as a result could not return the money
they had borrowed from other banks,
this would constitute a systemic risk event
in the interbank market.
Such an event occurred in the fall of 2008.
A second common component of systemic risk
is that it has an impact on economic activity.
Sometimes, economists refer to this impact
as on the "real" economy where "real" goods and services are
produced to distinguish it from the monetary side
of the economy where financial transactions take place.
So for example, the impact of a systemic banking event
in which banks as a whole reduce their mortgage
loans to households who want to buy houses
would negatively affect the construction industry,
the real estate industry, and the demand
for new appliances and new furniture and so on--
the real economy.
To be able to thwart systemic risks with policies
and regulation, oversight bodies and regulators
have found it useful to consider two
components of systemic risk--
the time series component and the cross-sectional or
structural component.
For simplicity, we'll call the second one
just the cross-sectional component.
The time series component refers to risks that develop over time
resembling a cycle not unlike a business cycle.
The cross-sectional component refers to the notion
that multiple institutions or markets face difficulty nearly
simultaneously.
And one default can lead to multiple defaults like a domino
effect.
After discussing the time series component in the next video,
we'll cover the cross-sectional component, returning
to the platform to consider how the private sector itself can
take some steps to lower these types of systemic risk
or at least better anticipate them.