Types of Financial Crisis - - That Can Lead to Wide-Scale Drop in The Value of Financial Assets of Your Business

A financial crisis is a sudden wide-scale drop in the value of financial assets, or in the financial institutions managing those assets (and often in both). A financial crisis may be triggered by a variety of factors, but the situation is typically aggravated by negative investor sentiment – fear or panic. A financial crisis often sparks a vicious circle where an initial decline sparks fears by investors that other investors will pull their money out, leading to redemptions and increasing declines. The global credit crunch of 2008 is an example of a financial crisis that resulted in such severe runs on the banks and other markets that investment banks such as Bear Stearns and Lehman Brothers, who have been around for more than 100 years, were bankrupted.

Types of Financial Crisis

A financial crisis can usually be categorized as one of the five types:

• Banking crisis: This is triggered by a sudden withdrawal of bank deposits by several clients, a situation known as a bank run. Banks may not have sufficient funds to simultaneously pay back numerous depositors, since they loan their funds. This credit crunch situation impacts the economy, as it affects production as well as consumption.


• Bursting of a bubble: Financial bubbles are caused by the overvaluation of assets, with prices exceeding the current value of the future income expected to be generated by these assets. Bubbles are doomed to eventually burst, with crashing prices. The Wall Street Crash of 1929 is an example of this type of financial crisis.


• Currency crisis: A country that maintains a fixed exchange rate may have to suddenly devalue its currency. This often leads to a sudden drop in foreign investments. The Asian currency crisis of 1997-1998 began with Thailand devaluing the baht and developed into most of Southeast Asia and Japan witnessing falling currencies.

• Sovereign default: A government may fail to repay its sovereign debt. This often leads to a sudden decline in capital inflows and a spike in capital outflows.

• Wider economic crisis: An economy may go through a period of slow or negative GDP growth. While slow economic growth may be called economic stagnation, negative GDP growth for more than a couple of quarters is recession. A prolonged recession is called depression.

Financial Crises of 2008-09

The global financial crisis of 2008–2009 was triggered by the bubble and eventual crash of the US housing market towards the end of 2007. The situation was aggravated by the growth of the subprime mortgage market in the US and subsequent defaults. The constant decline in house prices in 2008 caused an increase in foreclosures on mortgages. Investors lost confidence in their holdings of mortgages in securitized assets. This caused a widespread demand for liquidity, adversely impacting the financial and money markets.