Topic F financial crisis 2

Exam logic

Why do financial crises’ happen ?

Because info asymmetries occur and worsen sharpley

Info breakdown → credit misallocation → defaults → panic → crisis

Why can financial innovation create crisis?

New products can encourage excessive risky lending

Innovation improves → lending standards fall → defualts increase later

Why does deposit insurance sometimes increase risk taking ?

Banks know deposits are protected.

Safety net → weaker borrowers are financed → defaults eventually rise

Why do credit booms often end in crisis?

Risky lending accumulates over time.

Credit expansion → weaker borrowers financed → defaults eventually rise

Why are asset price bubbles dangerous ?

Falling asset prices weaken borrower networth

Why does institutional uncertainty worsen crisis?

Investors struggle to assess risk

Why do bank runs occur?

Depositors cannot tell which banks are solvent.

Why can healthy banks fail during a pandemic?

Forced asset sales reduce balance sheet value

Why is debt deflation dangerous?

Falling prices increase real debt burdens.

Why are crises often worse in emerging markets?

Banks dominate finance and regulation is weaker

Why can financial liberalisation trigger crises in emerging economies?

Banks may lack expertise to screen risky borrowers.

Why does weak supervision increase financial fragility?

Banks can pursue excessive risk.

Why might politicians weaken regulation?

Financial firms lobby for profitable high-risk activity. principal agent problem

Why do fixed exchange rates increase crisis risk in emerging markets?

Speculators can attack overvalued pegs

Why do fiscal imbalances contribute to currency crisis?

Investors lose confidence in repayment ability

Why can raising interest rates during a crisis worsen banking problems?

Higehr rates reduce asset values and borrower cash flows.

Why might central banks avoid raising rates during a currency crisis?

Protecting banks may matter more than defending the currency.

Why do speculative attacks become self fulfilling?

Everyone sells before expected depreciation. (1992 Crisis germany)

Why is currency mismatch dangerous?

Depreciation increases foreign debt burden

Why are twin crises especially servere?

Banking crises and currency crises amplify eachother

why is macroprudential policy focused on the whole system?

Individual bank safety does not guarentee systemic stability

Why is systematic risk difficult to manage?

Financial institutions are highly interconnected.

How does macroprudential regulation reduce leverage cycles?

It limits excessive borrowing during booms. e.g. countercyclical capital buffers