Channels of infection can be direct contagion through financial linkages or indirect contagion through asymmetries of information, panics, or fire sales. Through such channels, decisions by individual market participants can have external effects on the functioning of the financial system.
Such “externalities” are all the greater, depending on how pronounced the risk-taking incentives are, how high the leverage of individual market participants is, how large the institutions are (“too big to fail”), how connected they are (“too connected to fail”), and how high common exposures to similar risks are (“too many to fail”).