Financial crisis : consequences and prevention 28357

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What is financial crisis?

A financial crisis is a situation which the supply of money is outpaced by the demand for money. This means that liquidity is quickly evaporated because available money is withdrawn from banks. Thus, a financial crisis is a situation when money demand quickly rises relative to money supply.

More generally, financial crisis is a situation in which some financial institutions or assets suddenly lose a large part of their value caused by deterioration of a group of financial indicators, such as short?term interest rates and asset prices, potentially also accompanied by failures of financial institutions.

Until a few decades ago, a financial crisis was equivalent to a banking crisis. Today it may also take the form of a currency crisis. This leads us to give different types of crises :

• Banking crisis : this is called bank run . Since banks lend out most of the cash they receive in deposits, it’s difficult for them to quickly pay back all deposits if these are suddenly demanded, so a run may leave the bank in bankruptcy.

• Speculative bubbles and crashes: Economists say that a financial asset (stock for example) exhibits a bubble when its prices exceed the value of the future income (such as interest and dividends). The formation of a bubble is a factor for price volatility, so significant risk. That causes crashes.

• Currency crisis or balance of payments crisis: : When a country that maintains a fixed exchange rate is suddenly forced  to devalue its currency because of a speculative attack

Wider economic crises : A downturn in economic growth lasting several quarters or more is usually called a recession . An especially prolonged recession may be called a depression, while a long period of slow but not necessarily negative growth is sometimes called economic stagnation.

Consequences of a financial crisis

Consequences of a financial crisis are many, among which may be listed as an example:

Banks one after the other fail;

Interest rates to borrow increases;

The prices are revised upwards;

The property is sold poorly ;

It creates bankruptcy of big companies like VSE (very small enterprises) and SME (small and medium enterprises);

The unemployment rate increases ;

Liquidity crisis ;

The disruption of banking landscape;

Decline in economic growth worldwide by the slowdown of growth of GDP;

Decline in consumption of households;