Dynamics of Financial Crises

5 Key excerpts on "Dynamics of Financial Crises"

• 

  eBook - ePub

  Understanding Financial Stability

  • Indranarain Ramlall(Author)
  • 2018(Publication Date)
  • Emerald Publishing Limited

    (Publisher)

  Chapter 6

  Financial Crises

  6.1. Key Features of A Crisis

  • Economic and financial crises tend to be recurrent in nature. This implies that the same phenomena are at work to constitute the genesis of a crisis.
  • Nearly, all crises exhibit three common elements. First, there is distrust in the financial system or lack of confidence in the financial system. Second, there are spillover or contagion effects such as in the case of Allen and Gale (2009) who base themselves on the contagious transmission of bank difficulties. Third, there are network effects based on endogenous interactions among different financial institutions.
  • A crisis is usually financial in first stage to then entangle the real economy in the second stage. This can be corroborated by the evolution of the global financial crisis in 2007 into an economic crisis and thereafter into a debt crisis.
  • Crisis often occurs because market players assume that EMH (all relevant information is automatically reflected in the price) holds while in practice it is hard to see that assets are properly priced – a clear instance of this appears during the US subprime crisis.
  • Humans have a strong tendency to herd so that deleveraging of assets often witnesses a highly painful adjustment in the financial system, all geared towards an unending downward spiral in asset prices.
  • Crises are often caused by two events, a euphoria phase and a de-illusion stage. Under the euphoria stage, there are strong incentives to push forward asset prices while in the de-illusion stage, investors began to realise of over-valued assets which then lead to massive sell-offs and drastic asset price declines. The leverage cycle (Geneakopolous, 2009) contributes to higher asset prices. When the de-illusion stage manifested in the case of the US subprime crisis, it led to negative equity holdings by borrowers who had no choice but to deliberately default on their home loans.
  • Political forces can also contribute to crises. For instance, in the case of the US subprime crisis, there were strong political incentives to make each household own his home.

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  eBook - ePub

  The Inexorable Evolution of Financialisation

  Financial Crises in Emerging Markets

  • Domna M. Michailidou(Author)
  • 2016(Publication Date)
  • Palgrave Macmillan

    (Publisher)

  The on-going world recession and continuously deepening Eurozone debt crisis bring to the forefront of discussion the need for economic policy designed to tackle financial instability. The question thus addressed in this book is essential for the identification of the nature and volume of intervention needed in financial markets. The hazard of financial instability has become central in development economics, and increasingly there has been discussion on the nature of required policy design and intervention. Creating a framework inimical to systemic financial crises has been historically a major concern of policymakers, but now more than ever this development is in need of urgent realisation. Understanding the mechanisms behind the occurrence of systemic financial crises and averting their incidence could be an important first step for policy towards this direction. It is exactly to this field that this research attempts to make a contribution.

  To understand how capital flows can induce volatility in financial markets, and consequently to the whole of the economy, the book investigates a series of specific and inter-connected developments which, given the economies’ macroeconomic fundamentals, contributed to the crises that occurred. These are the causes of the abrupt increase in the stocks and flows of financial capital, the reasons behind their direction towards new outlets – specifically emerging economies – and the policies pursued in the recipient countries to deal with the inflows and the type and maturity-horizons assigned to the inflows. With regard to the factors causing the abrupt jumps in the generation and circulation of flows, we identify external and internal factors contributing to the changes and shaping the levels of financial capital in the emerging world. Following the work of distinguished scholars, a distinction is drawn between supply-push and demand-pull factors related to the jumps of capital flows (see Palma, 2003a, 2011a). The first are specific to the generation of liquidity through deregulation, financial engineering and lower profit opportunities manifested in the lower returns of US Treasury bonds and the overall slowdown of economic growth in the Western markets. The second are specific to changes applied to the overall economic policies and financial markets of emerging economies. This is delivered to set the background against the attraction of all capital inflows which when combined with an analysis of their type and maturity allows us to shape conclusions on the real causes of the crises.

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  eBook - ePub

  The Bank Credit Analysis Handbook

  A Guide for Analysts, Bankers and Investors

  • Jonathan Golin, Philippe Delhaise(Authors)
  • 2013(Publication Date)
  • Wiley

    (Publisher)
• Banks see sources of funding become costly or dry up entirely. Liquidity is thereby weakened, making the funding of new loans problematic, while margins are squeezed.
• Existing asset quality problems reveal themselves as lending declines. Bad loans turn sour and become a larger percentage of a contracting loan book.
• Profits take a hit from new loan-loss provisioning requirements generated as a result of the souring loans. As these requirements become increasingly difficult to meet from dwindling earnings, bank capital is impaired.
Once the crisis begins to affect the real economy, as it almost inevitably must, a vicious cycle is initiated making the restoration of confidence and bank capital, earnings, asset quality, and liquidity increasingly difficult.54

Currency or Financial Crises and Their Relationship to Banking Crises

[A financial crisis ]
is a situation where it becomes publicly known that the central bank has run out (or is about to run out) of reserves and could shortly become unable to service the country’s foreign-currency debt obligations
.55
—Alexandre Lamfalussy56
Distinct from a banking crisis, but often associated with, or even also defined as a financial crisis, is a currency crisis, which describes the precipitous decline in country’s domestic currency relative to a reserve currency, such as the U.S. dollar or the euro. A currency crisis can also be said to occur when a speculative attack intended to force a devaluation costs the affected country’s central bank a substantial sum to avert. The currency crisis often turns into a financial crisis when the country is no longer in a position to defend its currency. The essence of a currency crisis is either a large devaluation of a country’s currency, or the threat of such a devaluation that results in substantial expenditure of funds by the central bank. As is a banking crisis, a currency crisis is invariably accompanied by a rapid shift in market sentiment. The manifestation of a full-blown currency crisis will almost inevitably be followed by a destruction of wealth that puts the brakes on the real economy, and it may trigger a banking crisis if one is not already in progress.57