Financial Risk Manager

Ways of Financial and Risk Management

Crises and its causes
Wednesday, February 11, 2009

Crises take different forms. They can be characterized by

a large decline in consumer demand and investment by firms,

higher unemployment,

and a lower standard of living,

uncertainty in financial markets,

declines in the prices of stocks, bonds and, quite frequently, the value of the domestic currency.

Crises can originate in or affect the financial sector, and can lead to difficulties in banks and the payments system, causing damage to economic activity as well. A very severe crisis (economic and/or financial) could lead to recession, debt defaults, and what is known as a sudden stop: a deep recession and a reversal in the flow of international capital.

Crises in emerging markets can be caused by external or domestic factors. External causes comprise

a collapse of export prices,

a drastic increase in import prices,

a shift in investor perceptions about risk that cause capital outflows,

a large depreciation or devaluation of the currency of a close trading partner,

a retrenchment of local activities of international banks,

a sharp curtailment of credit or increase in interest rates in world markets.

Domestic causes include

excessive monetary creation,

unsustainable fiscal deficits,

an overvalued domestic currency,

political instability,

and natural disasters.

External shocks can have a multiplying effect on vulnerable countries, which tend to have relatively high levels of private or public debt, weak financial systems, and a history of instability and inappropriate policies.

Labels: Economy and Business, Financial crisis