— Ch. 1 · Defining Financial Crises —
Financial crisis.
~5 min read · Ch. 1 of 6
A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. This definition distinguishes the event from an economic crisis, which involves a broader reduction of economic activity affecting the whole economy. In the 19th and early 20th centuries, many financial crises were associated with banking panics. Many recessions coincided with these panics during that era. Other situations often called financial crises include stock market crashes and the bursting of other financial bubbles. Currency crises and sovereign defaults also fall under this category. Financial crises directly result in a loss of paper wealth but do not necessarily result in significant changes in the real economy. The famous tulip mania bubble in the 17th century serves as an example where the crisis did not precipitate a major financial disaster.
Types And Classifications
When a bank suffers a sudden rush of withdrawals by depositors, this is called a bank run. Since banks lend out most of the cash they receive in deposits, it is difficult for them to quickly pay back all deposits if these are suddenly demanded. An event in which bank runs are widespread is called a systemic banking crisis or banking panic. Examples of bank runs include the run on the Bank of the United States in 1931 and the run on Northern Rock in 2007. A currency crisis, also called a devaluation crisis, occurs when participants in an exchange market recognize that a pegged exchange rate is about to fail. Frankel and Rose define a currency crisis as a nominal depreciation of a currency of at least 25 percent. Kaminsky et al. define it differently based on weighted average monthly percentage depreciations exceeding three standard deviations. Speculative bubbles exist when large sustained overpricing of some class of assets takes place. These bubbles often involve buyers who purchase an asset based solely on the expectation that they can later resell it at a higher price. Well-known examples include the Wall Street crash of 1929 and the Japanese property bubble of the 1980s.