Counterparty Risk: Diversify Institutions, Not Just Assets
By Diego Alcalá In September 2008, while savers slept soundly believing their money was "safe" at the bank, Lehman Brothers — a Wall Street giant with 158 years
By Diego Alcalá · Thu Sep 03 2026 · investing
By Diego Alcalá
In September 2008, while savers slept soundly believing their money was "safe" at the bank, Lehman Brothers — a Wall Street giant with 158 years of history — collapsed like a house of cards. Millions of investors lost everything, not because they picked the wrong investment, but because of something few of them had ever considered: counterparty risk.
Think about the vulnerability you feel the moment you realize that an apparently solid institution can vanish overnight, taking with it the wealth of everyone who trusted it. Counterparty risk is not an academic concept.
What counterparty risk actually is
The definition is simple: counterparty risk is the possibility that the person or institution on the other side of your financial transaction cannot meet its obligations. In plain terms, it is the risk that your counterparty fails and you cannot get your money back.
Unlike other risks, this one is silent. It does not show up on a price chart, and it does not make the news until it is too late.
Charlie Munger, Warren Buffett's partner, insisted that it is far better to buy a wonderful company at a fair price than a fair company at a wonderful price.
Three collapses that rewrote financial history
Lehman Brothers was not just an investment bank. It was an institution many considered "too big to fail." Its collapse proved that neither size nor history guarantees survival.
FTX, the cryptocurrency exchange that collapsed in 2022, is a reminder that counterparty risk evolves alongside new technology. Thousands of users believed their digital assets were safe on the platform, only to discover that Sam Bankman-Fried had been using client funds for his own speculative trades. Technological innovation does not eliminate fundamental human risks.
Bernard Madoff ran a Ponzi scheme for decades, promising consistent returns without ever clearly explaining the strategy behind them. Sophisticated investors — hedge funds and wealthy families among them — trusted him for his reputation and his connections. When the scheme collapsed in 2008, more than 65 billion dollars were gone.
These cases share one denominator: blind trust in institutions or individuals without doing the necessary diligence. As the Russian proverb Ronald Reagan popularized puts it: "Trust, but verify."
Where this risk lives inside your portfolio
Counterparty risk operates in many forms. At the most basic level, every time you deposit money in a bank you are taking on counterparty risk. You are trusting that the bank will return your money when you ask for it. Deposit insurance covers limited amounts, so large balances remain exposed.
This matters more, not less, when you invest across borders. A Canadian investor holding assets in the United States is dealing with a different set of institutions and a different protection regime than the one back home: CDIC coverage in Canada, FDIC coverage for US bank deposits, SIPC protection for US brokerage accounts. Each has its own limits, its own categories and its own exclusions, and none of them covers everything. Before you move capital into another country, find out exactly who stands behind the account and what happens if that institution fails.
In investments, this risk shows up when you buy corporate bonds, invest in funds, or use derivatives. With bonds, you take on the risk that the issuer cannot pay interest or return your capital. With funds, you depend on the manager handling the money properly.
Derivatives markets amplify it. In 2008, AIG nearly collapsed because of its credit default swap positions. The company had sold insurance against subprime mortgage defaults without holding reserves anywhere near sufficient to cover the losses that materialized.
Even in seemingly safe instruments such as bank certificates of deposit, counterparty risk is present. During the 2008 crisis, some money market funds "broke the buck" — they could not maintain the nominal value of their shares because of losses in their holdings.
Diversify counterparties, not just assets
Managing counterparty risk well requires more than diversifying assets. First, diversify not only your investments but your counterparties. Do not concentrate your entire net worth in a single institution, no matter how solid it looks to you.
Before you trust your money to any institution, investigate its financial health, its track record, its corporate governance structure, and its exposure to systemic risk. Audited financial statements, credit ratings and market reputation are useful indicators, though never infallible.
Always keep a share of your wealth in assets that do not depend on external counterparties. Real estate you own directly, gold, and investments in your own business can serve as shelters from counterparty risk.
For investments that do require counterparties, favor institutions with history, regulation and conservative structures. They may offer slightly lower returns, but the peace of mind is worth the difference over the long run.
Deposit insurance protects part of your capital, but do not rely on it exclusively. Consider as well the coverage that clearing houses provide in organized markets.
Redundancy is the price of safety
Nassim Taleb coined the term "antifragility" to describe systems that get stronger under stress. Applied to counterparty risk, an antifragile portfolio is one that not only survives the failure of a counterparty but can benefit from it.
When you invest through intermediaries, use several platforms and managers. If one fails, the others keep operating. That redundancy has a cost, and the cost is the price of protecting your wealth.
Consider the geographic dimension too. Concentrating every investment in institutions of a single country exposes you to that country's systemic risk. Geographic diversification is complex to implement, but it is necessary to preserve wealth over the long term. For a foreign investor, this cuts both ways: moving everything abroad is as concentrated a bet as never leaving home.
Counterparty risk can surface very quickly in a crisis. Set up alerts on the financial health of your main counterparties and be ready to act if you see signs of deterioration.
Your wealth depends on who holds your money
Counterparty risk reminds us of a truth about finance: in an interconnected world, our wealth depends not only on our own decisions but on the integrity and solvency of those who hold our money.
The 2008 crisis taught us that institutions "too big to fail" can, in fact, fail. The more recent collapses of FTX and other financial intermediaries confirm that these risks have not disappeared. They have simply evolved and migrated toward new platforms and technologies.
Managing counterparty risk should not paralyze your investment decisions, but it should inform them and add a layer of analysis. A conservative but intelligent approach means diversifying counterparties, keeping a share of your wealth in assets under your direct control, and never putting all your eggs in the same institutional basket.
As I have argued in earlier pieces, investing is not only about maximizing returns. It is about building sustainable wealth that can withstand the inevitable black swans of the financial system. Counterparty risk is one of those unexpected events, and being prepared can be the difference between preserving and losing decades of work.
So: have you evaluated the counterparty risk in your portfolio lately, or are you still trusting blindly that every one of your financial institutions will be there when you need it?
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This content is educational and informational, and does not constitute investment, legal or tax advice. All investing involves risk and should be evaluated according to each person's particular circumstances.
Spanish version: El riesgo de contraparte
Image: the Lehman Brothers corporate sign displayed in Christie's window in London before being auctioned as lot 1002 of the "Lehman Brothers: Artwork & Ephemera" sale, October 2010. Photograph by Jorge Royan, CC BY-SA 3.0.