Causes of financial crises

Financial crisis: definition

As soon as humanity began to carry out some semblance of financial transactions (using mollusk shells, squirrel skins or dolphin teeth as money), the danger of a financial crisis immediately loomed over it. Fortunately, there were countless squirrels and dolphins in those distant times. But, nevertheless, already in 88 BC, the first financial crisis known to world history occurred in the Roman Republic. Its causes were political instability and military conflicts (the first Mithridatic War 89 - 85 BC).

A financial crisis is spoken of in situations where certain financial assets lose most of their nominal value. In the past, financial crises were associated primarily with a decline in banking. Currently, this concept is associated not only with banks. This term also refers to situations such as:

1. Currency crises;
2. Sovereign defaults;
3. Various large financial bubbles (at the moment of their collapse).

Moreover, although financial crises lead to the loss of money and other assets, they do not necessarily have to affect the real sector of the economy.

The main signs of a financial crisis are:

1. Sharp increase in interest rates;
2. An increased number of bankrupt and on the verge of bankruptcy banks and other financial organizations;
3. Significant reduction in the number of loans issued;
4. A rapidly increasing number of problem debts (both for individual companies and for the state as a whole);
5. A noticeable deterioration in the situation on the stock market (decrease in liquidity and fall in securities prices);
6. Delays in settlements, an increase in the number of non-payments and a crisis in the payment system;
7. The emergence of serious problems in balance sheets (from the balance sheet of an individual enterprise to the balance sheet of the country as a whole);
8. Large-scale withdrawal of capital from the country;
9. Depreciation of the national currency;
10. Rising prices turning into chronic inflation;
11. Reducing the size of the country's reserves and state stabilization funds;
12. Increasing state budget deficit;
13. Decrease in tax revenues to the country's budget;
14. Significant reduction in government spending items;
15. Banking panic.

In general, the financial crisis is a multidimensional concept that is difficult to define by any limited set of indicators. It covers financial markets as well as international, government, municipal and corporate finance. It is reflected in the credit market and all activities related to the organization of money circulation.

In the modern world, the economies of various countries are interconnected in one way or another. Therefore, as a result, as a rule, a breakdown of the credit and financial system occurs not in one, but in a whole number of states (especially dependent, in this case, are economically less developed countries). And this entails the emergence of significant imbalances in the conduct of international monetary transactions. Thus, a simultaneous coverage of the most diverse areas of the global financial system occurs and the next global financial crisis begins.

Financial crisis concept

A financial crisis refers to quite a variety of situations during which some financial companies or assets (for example, stocks or bonds) suddenly lose a significant part of their value.

It is clear that financial crises primarily affect the financial sector of the economy. However, due to the fact that the real sector is closely connected with the financial sector, such crises are ultimately reflected in all spheres of the economy and lead to a decline in production, increased unemployment, a decrease in the well-being of the population, etc.

Types of financial crises

Typically, the following types of financial crises are distinguished (according to the classification proposed by Michael Bordo):

1. Bank;
2. Foreign exchange;
3. Debt;

The cause of the banking crisis is the massive withdrawal of money by depositors from their bank deposits. Since most of the funds are used by banks for lending, they simply do not have the opportunity to pay everyone at once. This, in turn, leads to massive bankruptcy of financial and credit institutions.

A banking crisis is characterized by a situation called a banking panic, when depositors are afraid of losing their money and withdraw it en masse from their deposits.

One of the most significant consequences of a banking crisis is usually a long-term recession in the economy. This is due to the fact that the country's enterprises are deprived of bank loans, which greatly slows down their reconstruction and development.

Currency crises arise when the majority of foreign exchange market participants, for whatever reason, come to the conclusion that the current exchange rate of the national currency is on the verge of collapse. The consequence of this is an avalanche of speculative transactions, as a result of which such a collapse really becomes inevitable.

There are no clear numerical criteria for defining a currency crisis. Some economists believe that its beginning is evidenced by the depreciation of the national currency by more than 25%. According to others, an indicator of the onset of a currency crisis can be considered a situation when the weighted average of the monthly depreciation of the national currency exceeds three standard deviations from its average value.

A debt crisis occurs in a situation where the accumulated debt burden (both of individual enterprises and the country as a whole) leads to an inability to satisfy all creditor demands. For an enterprise, such a situation threatens bankruptcy, and for a country, failure to fulfill its debt obligations means nothing more than a sovereign default.

Default, usually accompanied by devaluation of the national currency, leads to a massive outflow of foreign capital from the country, and the volume of investment in its economy is sharply reduced. For most potential investors, this kind of circumstance is like a red traffic light; they not only do not plan to invest in such an economy, but, if possible, withdraw all funds previously invested in it.

Types of financial crises

Now that we have made our first acquaintance with the concept of a financial crisis and its consequences, let’s move on directly to the types of financial crises:

Banking crisis

A banking crisis is a situation where a bank experiences a sudden and massive influx of customers wanting to withdraw deposits, resulting in the bank being unable to pay all depositors.

It is worth clarifying that in the described situation there is no element of fraud on the part of the bank: the banking system is designed in such a way that banks earn money by issuing loans at the expense of depositors; It is clear that a sudden demand for a refund cannot be fulfilled by the bank without “outside help.”

A situation where many banks simultaneously experience an influx of customers wanting to withdraw their deposits is called a systemic banking crisis .

It is clear that if, in the event of a crisis, a bank (or several banks - in a systemic crisis) does not receive support from the outside, there is a threat of bankruptcy of the bank itself. Also, in a crisis, the bank stops issuing loans, which has a dramatic impact on producers of goods and services who need loans for normal functioning. This is how the banking crisis spreads throughout the entire economic system.

Examples of crises of this type are, for example, the banking crises in Latin America in the 1980s.

Market bubble crashes

Economists say that a financial asset exhibits a bubble if its price exceeds the present value of future earnings from that asset.

In other words, a bubble occurs when the price of an asset is unreasonably high compared to the returns that the asset itself will generate. Thus, this is a situation where people are too optimistic about the prospects of a particular asset.

It is clear that such a situation cannot last forever, and sooner or later the bubble will burst 1. As a result of the rapid decline in the value of assets, their owners become sharply poorer. What was worth a lot yesterday may be worth nothing today. Since various assets in developed economies are often used as collateral or guarantee to attract other loans, a sudden loss of funds leads to a decrease in the credit rating or even bankruptcy of the 2 owners of the depreciated assets. It is clear that in the event of mass bankruptcies, creditor companies of today's bankrupts become candidates for bankruptcy tomorrow.

It is very important that, as a result of such shocks, both the directly affected companies and their partners change their behavior to a more cautious one: new investment projects are postponed, hiring is suspended, and production volumes are reduced. All this can lead to a “slowdown” of the economy - stagnation .

Examples of bubbles: the Dutch tulip mania, the Japanese real estate bubble of the 1980s, the high-tech (dot-com) bubble of 2000, the 2007 bubble in the US mortgage-related securities market, etc.

1. It should be noted that not all bubbles burst: sometimes a revaluation of expectations and, accordingly, a decrease in price can occur gradually. In these cases, they talk about “deflating” the bubble.

2. This happened in 2008, when, after the collapse of the bubble in the market for assets related to mortgage obligations, many companies that held such assets in their accounts went bankrupt.

Currency crisis

A foreign exchange crisis, or, as it is also called, a foreign trade balance crisis, occurs when the value of the domestic currency changes sharply.

Such situations can be either the result of voluntaristic actions of governments or the consequences of so-called speculative attacks. So, for example, when the active sale of foreign currency assets by foreign (capital outflow) and domestic investors begins, the exchange rate begins to experience “pressure”. This situation is aggravated if the country has adopted a fixed exchange rate system: the state has to choose between spending a significant amount of reserves to support the exchange rate and a sharp change in the exchange rate to ease the “pressure”. As a result, the currency often changes its value sharply, which leads to consequences for both the real and financial sectors.

An example of a currency crisis is the sharp devaluation that occurred after the Russian sovereign default in 1998.

Sovereign default

A sovereign default is the bankruptcy of a state: a situation in which a state admits that it cannot pay its obligations.

Like a currency crisis, a sovereign default can result from both ill-advised economic policies and economic shocks. In any case, immediately after the announcement of a sovereign default, government obligations sharply lose value, capital outflow begins, and the threat of a currency crisis arises.

An example of a sovereign default is the 1998 crisis in Russia.

Liquidity crisis

The concept of a liquidity crisis describes one of the situations:

• A general state of mutual distrust in the banking system, which leads to the temporary disappearance of loans.
• A shortage of cash that a particular company is experiencing.

Sometimes the term is used as a synonym for the concept of credit reduction .

If we talk about a liquidity crisis that appears throughout the economy, then it is in a sense a special type of financial crisis: most often it arises as the first consequence of other crises, for example banking crises or the collapse of speculative bubbles.

A situation of liquidity crisis was observed, for example, in the American market after the collapse of the mortgage-related securities bubble in 2007.

Causes of financial crises and their consequences

Crises do not arise on their own; as a rule, they are always preceded by a number of specific reasons and circumstances. They quite rarely occur in isolation from other events and are not so much the cause of the decline as a mechanism for its intensification. Favorable conditions for the development of a crisis are:

• Unstable political situation;
• Inflated exchange rate of the national currency;
• A weak financial system coupled with the inconsistency of macroeconomic policies pursued by the state;
• Unfavorable situation in foreign markets;
• Growing budget deficits and the country's balance of payments;
• Instability of the country's banking system.

In addition, the following reasons for their occurrence can be identified:

1. Speculative bubbles;
2. Leverage effect.

Speculative bubbles are formed as a result of unjustified (excessive) demand for any financial instrument or asset. The main desire of buyers, in this case, is to extract speculative profit from an increase in its exchange rate. At the same time, few people think about the income that the purchased asset can generate in the long term.

In this case, the rush demand continues exactly as long as the majority of buyers see the prospect of growth of this asset (financial instrument). And as soon as this growth stops and doubts arise in the minds of speculators about its further continuation, massive sales begin, which quickly lead to an almost complete depreciation of the asset in question (the bubble collapses).

the effect of leverage (leverage) can lead to the onset of a crisis When a business is conducted with a large amount of borrowed funds, even a relatively small shortage can lead to the insolvency of such companies. In the case when the basis of the company's capital is its own funds, it will be much easier for it to get a loan and survive difficult times and difficult periods (which, perhaps, more than one large business cannot do without).

In the same case, when the company's capital consists almost entirely of borrowed funds, it will be much more difficult for it to stay afloat in difficult times. Existing investors can withdraw their capital and few banks will agree to issue a loan to a company burdened with such an impressive debt burden. The company's failure to creditors leads to bankruptcy, which, if we are talking about not one, but a number of similar enterprises, can lead to a chain reaction. The bankruptcy of some companies leads to non-payment of debts to other companies, which, in turn, also, if they do not go bankrupt, then begin to experience certain financial difficulties.

Consequences of financial crises

– Rapid depreciation of the national currency. Inflation turning into hyperinflation and, as a consequence, uncontrolled price increases and a massive outflow of capital from the country;

– A decrease in the level of GDP and an increase in the country’s balance of payments deficit, aggravated by the uncontrolled growth of the country’s internal and external debt, as well as a significant reduction in gold and foreign exchange reserves;

– The emergence of a deficit in the credit market associated with massive bankruptcies of banks and other financial and credit institutions and, as a consequence of this, a slowdown, or even a complete stop, in the development of the production and monetary sectors;

– The speculative model of financial activity begins to prevail over the investment one. That is, everyone strives to make a profit in the shortest possible time period, and the investments necessary for the development of the country’s industry in the long term fade into the background.

Causes of financial crises

As noted by Prof. Nouriel Roubini, crises “do not appear out of nowhere, they are not some kind of anomaly”[3]. (See also The Business Cycle.) Authors of the acclaimed large-scale study of the history of global financial crises, This Time Will Be Different (2009) by Kenneth Rogoff and Carmen Reinhart [4], most major crises were preceded by financial liberalization[5][6] .

Financial leverage

Financial leverage allows you to run a business that, if there is a lack of borrowed funds, collapses automatically. This gives a domino effect, since even with a small lack of funds it leads to the insolvency of a large number of business participants.

Crowd effect

The crowd effect is associated with the operations of speculators who massively sell or buy assets and, thereby, transform weak declines and increases in prices into a landslide fall and rapid growth, which destabilizes the market.

Ways out of the crisis

Due to the complexity and versatility of such a phenomenon as the financial crisis, there is no single solution in this case. Each situation, for each individual country, is individual and, accordingly, requires the same individual approach. However, there are a number of general recommendations that make it possible, if not to get out of the crisis, then at least to reduce its harmful impact on the country’s economy.

These are the recommendations:

1. Provide employment for the population. The people will work, will pay taxes to the budget and, in the end, will consume more, thus stimulating domestic production. At one time, US President Franklin Roosevelt solved this problem by massive construction of highways in the country (thus he led the country out of the crisis later called the Great Depression);
2. Diversification of ways to generate budget revenues in such a way that in the event of a serious decline in one of the industries, other items remain to replenish it. When applied to the Russian economy, this is a reduction in oil dependence through the development of other industry segments;
3. Taking measures to curb inflation, introducing strict financial control over the exchange rate of the national currency and the level of interest rates;
4. Introduction of a set of measures to support key sectors of the economy (shifting the emphasis in the distribution of budget funds in their favor). Supporting industrial production in the country, promoting the introduction of innovations and new technologies.

Practical impact of crises

The first crises developed during the preparation for global conflicts and the redivision of the world. Western countries were more developed, which allowed them to influence the economies of other countries. But their experts failed to appreciate the danger of building a commercial economy based on capitalism. Initially, capitalist principles attracted entrepreneurs with their accessibility and quick payback. Therefore, they actively spread throughout the USA, England, and Germany.

Note 1

The rapid start of development inspired German leaders and made it possible to create an international global conflict. From an economic point of view, this was even more profitable because it allowed for additional financial benefits.

Finished works on a similar topic

• Course work Signs of economic crises 450 rub.
• Abstract Signs of economic crises 230 rub.
• Test work Signs of economic crises 190 rub.

Receive completed work or specialist advice on your educational project Find out the cost

Practice quickly showed the fallacy of these judgments. The leaders of the United States and England were the first to suffer the financial blow. They were followed by France, Japan and Russia.

Workers in these countries no longer clung to jobs as much because they gained freedom of choice and movement. During global conflicts, many workers chose to move to areas free from war. Labor migration arose. The consequence of its impact on the economy and population was a prolonged depression and unemployment. People assessed their value as a socio-economic resource and began to use this advantage. Let us consider the most active signs of the economic crisis in more detail.

How to make money on the stock exchange during the financial crisis

The stock market is quite sensitive to changes occurring at the macroeconomic level. Phases of economic development (economic cycles) entail quotes for most securities. The phase of economic growth is accompanied by rapid growth in stocks, and the phase of recession (including those associated with the crisis) usually pulls the stock market down.

How can you make money against the backdrop of a general decline in financial markets? There are at least two options to do this:

1. Try to make money by short selling securities;
2. Take advantage of the decline in prices in order to profitably purchase securities, and then sell them as the crisis emerges (or after its end).

It should be noted right away:

The equally vulnerable point of both of these methods is that it is never possible to determine with absolute accuracy the moment in time when the price reaches its bottom and reverses. In the first case, if such a moment comes too early, then you will not be able to take profit on short positions, and in the second, there is a rather serious risk of being thrown out of open long positions using a margin call.

Strategy one: make money on short sales

It's no secret that shares on the stock exchange can be both bought and sold. It is both understandable and self-evident: first I bought shares, and after a while I sold them, fixing a profit (if the price of the shares has increased) or a loss (if the price of the shares has decreased). However, not everyone knows that the specifics of trading in the stock market allow traders to sell shares even when they do not have them (the shares). Or, in other words, selling what you don't have.

At first glance, this contradicts logic and common sense, but let's look at this point in a little more detail and everything will immediately fall into place. But in fact, everything is quite simple here, the algorithm for short selling shares is as follows:

1. After a short sale order, the broker sells on your behalf not your shares, but his shares (you seem to be borrowing them from him to carry out your speculative operation);
2. After the stock price drops as expected, they are bought back at a lower price and the debt is returned to the broker;
3. You keep the difference in price between the initial sale and the subsequent purchase;
4. In the event that the shares, contrary to your expectations, do not decrease, but rather increase in price, you will receive a loss in the amount of the same difference between the sale and subsequent repurchase prices.

The broker carries out all the above manipulations independently, and uses the funds you contributed as margin as collateral (this kind of short selling is usually carried out using leverage).

You can read more about short selling or, as they are also called, short selling, by following this link.

Signs of an economic crisis

• Lack of effective management of the situation;
• The mechanisms of regulation and restoration are destroyed;
• Monitoring of the situation was carried out with a delay;
• There is no monitoring of the situation;
• The measures taken are spontaneous;
• The social system is changing;
• The number of migrants and unemployed is growing;
• The exchange rate of the national currency is falling.

Too lazy to read?

Ask a question to the experts and get an answer within 15 minutes!

Ask a Question

Consider the consequences of economic instability.