Financial Crises Flashcards
What is a financial crisis?
When some financial institutions or assets suddenly lose a large part of their nominal value
What are economic crises?
Economic recessions, real effects on GDP, GDP growth and unemployment
Name 3 things that lose nominal value in financial crises?
Stock prices, exchange rates, interest rates
What is a banking crisis?
A crisis with its origin in bank distress
2 ways a bank crisis can arise and definitions?
Credit crunch = financial institutions reluctant to lend due to insufficient funds available
Bank run = bank suffers rush of withdrawals from depositors due to low confidence
Explain the process of a credit crunch?
Lack of lending -> lack of supply of funds -> increase in interest rates -> potential real effects (eg. Fall in I and C)
Explain the process of a bank run?
Bank suffers rush of withdrawals from depositors due to low confidence
Why do financial crises spread so quickly between banks?
They all have financial links between them
2 policies to avoid banking crises and explanations of what they do?
1) deposit insurance - aims to eliminate depositors not trusting the bank tf prevents bank runs
2) promises of bail out - government gives/lends banks sufficient resources to survive the crisis
How much is deposit insurance in the UK?
85K/person
What are the consequences of promises of bail outs? 2 good, 2 bad?
Good:
Helps banks survive
Prevents crisis spreading
Bad:
Can cause moral hazard ‘too big to fail’
Debt crisis
What is a stock market crisis?
A sudden decline of stock prices across a significant share of a stock market
Where do stock markets come from?
Often result from a bubble which can originate from an overvalued asset on the market
2 ways to avoid bubbles and explain how?
1) monitoring - deters unwanted activity, enhances information transparency
2) regulation - clear set rules by governments, defines and punishes criminal activity
What is a currency crisis?
Crisis as a result of a country having to suddenly devalue its currency
What types of exchange rate regimes will be worst affected by a currency crisis?
Fixed and pegged ER regimes
How did the 07-08 financial crisis arise? What did it lead to? What were the consequences of it?
- overvaluing of bad mortgages -> bubble in property prices -> financial crisis
- financial crisis -> economic crisis
- economic crisis consequences: fall GDP, increase U, increase reliance from FI on public intervention, increase sovereign debt
Briefly describe the Great Depression of 1929? How did it end?
Crash in US stock markets -> depression
Continues til WW2
2 facts regarding unemployment and DJIA over the Great Depression?
DJIA lost 89% or value by 1932
Unemployment roughly 17% during 1930s
Describe briefly the Mexican peso crisis?
A sudden devaluation of the Mexican currency in 1994
The largest non-military international commitment since the Marshall plan: a $50bn intervention by the US government, the IMF, the Bank of International Settlements and various other actors was required in the form of emergency loans
Explain the Asian financial crisis of 1997? (What happened, how it spread, why it was so bad)
A build up of debt by the so-called Asian tigers led to severe pressure on their currencies, many of which operated according to a fixed exchange rate system
Began in Thailand but spread to regional neighbours
Dramatic falls in the value of the currencies of these countries led to unsustainable debt obligations since much of this debt was denominated in US$
Explain an example of the government debt crisis? How does it worsen further?
Eurozone crisis: result of large national debt -> contractionary fiscal policy
Large national debt due to bail outs and overspending
Crisis worsens when gov. can’t repay its creditors tf increase interest rates due to defaulting risk tf problems worsens further (money dries up)
Consequences of eurozone crisis?
Fall in welfare, fall in GDP, increase in tax, increase U, fall in growth
3 factors correlating to financial crises? And explained?
1) deposit insurance: dummy variable, expected negative impact on likelihood of a crisis
2) bank capital+total reserves:total assets ratio
Highlights credit and liquidity risk
Negative impact on prob of crisis
3)non performing loans:total gross loans ratio
If large proportion of assets are underperforming this can indicate higher chance of crisis (if NPL more than double in a year alarm should be raised) +ve correlation
See equation for prob. of banking crisis?
Now
