Core Concepts Flashcards
What is a financial crisis?
A financial crisis occurs when the value of financial institutions or assets drops significantly, disrupting the economy.
Name two types of financial crises.
Banking crises and currency crises.
What triggers a banking crisis?
Insolvency, illiquidity, or a sudden mass withdrawal of deposits (bank runs).
Define systemic risk.
Systemic risk is the potential collapse of the entire financial system due to the failure of one or more institutions.
What is moral hazard?
It occurs when institutions take excessive risks, believing they will be bailed out in case of failure.
What role do asset bubbles play in financial crises?
Asset bubbles inflate prices beyond intrinsic value, leading to sharp corrections when they burst, causing financial losses.
What is a currency crisis?
A situation where a country’s currency depreciates rapidly, destabilizing the economy
How does leverage contribute to financial crises?
High leverage increases risk exposure, making institutions vulnerable during economic downturns.
Define a credit crunch.
A credit crunch is a sharp reduction in lending by banks due to increased risk aversion.
What is a liquidity crisis?
A liquidity crisis occurs when financial institutions cannot meet short-term obligations due to a lack of cash or credit.
Explain the contagion effect in financial crises.
Contagion refers to the spread of financial distress across institutions or countries, worsening a crisis.
Why is deposit insurance important in banking?
It reduces the risk of bank runs by assuring depositors their funds are protected.
What are non-performing loans (NPLs)?
Loans on which borrowers fail to make scheduled payments, threatening a bank’s stability.
What role do central banks play during a financial crisis?
They act as lenders of last resort, provide liquidity, and implement policies to stabilize the economy.
Define quantitative easing (QE).
QE involves central banks purchasing financial assets to inject liquidity into the economy and stimulate growth.
What is the “too big to fail” doctrine?
The belief that large, interconnected institutions must be supported to prevent systemic collapse.
How do fiscal policies help mitigate financial crises?
By increasing government spending or cutting taxes to boost demand and stabilize the economy.
Name one key cause of the 2008 financial crisis.
The collapse of the U.S. housing market and subsequent defaults on mortgage-backed securities.
What are sovereign debt crises?
These occur when a country cannot meet its debt obligations, leading to defaults and economic instability.
How do credit rating agencies influence financial crises?
By assigning creditworthiness grades that can affect borrowing costs and market perceptions.
What is financial deregulation?
The process of reducing government oversight and restrictions in the financial industry.
How do speculative investments affect financial stability?
Excessive speculation can inflate asset bubbles, increasing the risk of sharp market corrections.
What is a shadow banking system?
Non-bank financial intermediaries that provide services similar to traditional banks but operate outside regulatory frameworks.
How do balance sheet issues lead to banking crises?
Weak balance sheets with high debt levels or bad assets increase the likelihood of insolvency during economic downturns.
What is capital adequacy, and why is it important?
It is the minimum amount of capital banks must hold to absorb losses and maintain stability.
