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The Increasing Importance of Systemic Risk

March 31, 2011

Over the last decades, organisations have been focused on internal risk – fraud from employees or customers, defaults by suppliers or customers.  Few have paid attention to external systemic sources of risk – from changes in the economic, environmental or energy systems.  Think about the challenges to our economy from our environmental system for instance.

Events in Japan  –  The recent events in Japan have highlighted the potential impact of natural disasters on modern economies. In Japan, as in many countries, a large proportion of the population live near the sea, and so are open to incursion of the sea – through tsunami as in the case of Japan – or flooding at high tides or through storms.  The numbers of people affected by natural disasters is often many times higher than man-made disasters – think of the numbers affected by the Chernobyl nuclear disaster – 64 dead and up to 4,000 affected by WHO estimates – compared with the thousands dead from the Japanese tsunami.

This particular disaster did not strike a megacity: but the scale, growth and complexity of megacities, including land use, drainage and exposure, coupled with access to consistent and reliable data makes quantitative risk assessment of the ensuing problems difficult [1].  Concern over megacities in the Asia-Pacific region such as Dhaka, Jakarta, Bangkok, Shanghai and Manila is particularly acute, as many combine high exposure to risk with low resilience or ability to cope.

La Nina  – We are at the depths of a Niña right now.  The probable cause is the absence of any sun spots at all for five straight years, which last happened in the 1660s when whole oxen were supposedly roasted on the Thames ice.

La Nina is caused by a phenomenon called the “quasi biennial oscillation”, which ticks like a slightly wobbly clock, apparently synchronised to the 22 year sun spot cycle – which alters solar output by a half percent of so.  Any one tick can be weak or strong, so for example we had an exceptional Niño in 1997, running straight into a strong Niña immediately afterwards.

How does it work?  When hot water flows out from around PNG and the Celebes into the South East Pacific, it pushed back the cold Humboldt current.  The result is (usually) floods in California and (always) in Latin America: a Niño.  When the opposite happens, hot water becomes pent up around PNG/Northern Australia and the Humboldt extends Northwards.  This is a Niña, giving droughts in Latina, floods in Asia, Australia; extreme cold in the mid-Northern latitudes as the jet stream swings North.

This means insurance premiums up, oil demand up, commodities from North America – Canadian wheat for example – is disrupted.

Are the causes of systemic risk more frequent than in the past?  – There is some evidence that we are in an unusual weather phase – eg La Nina.  There is much evidence that our environmental systems are under pressure – eg [2] the decline of big fish stocks by 90% from 1950 to 2003.  And finally, the pressure of population means that many more people are affected when there are environmental events (as tsunamis) or trends (as in Canadian wheat).

So organisations need to be aware of systemic risk from three directions:

–   from pressure on our environmental systems,

–   from pressure of population and its location, and the effect of  natural disasters

–   and from weather patterns which have a major impact on our tightly integrated systems.


Written by Gill Ringland, CEO at SAMI Consulting

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