Three Stages Of The Financial Crisis

A financial crisis is a situation where the value of financial institutions or assets rapidly decreases. According to Federic Mishkin, “a financial crisis occurs when an increase in asymmetric information from a disruption in the financial system causes severe adverse selection and moral hazard problems that render financial markets incapable of channelling funds efficiently from savers to house-holds and firms with productive investment opportunities.” Mishkin continued saying, “When financial markets fail to function efficiently, economic activity contrast sharply.” In recent history Jamaica has been hit by two major financial crisis, one in the 1980’s and the other in the mid 1990’s. This second major financial crisis was due to several

The financial crisis can be outlined by three stages. Stage one is the initiation of the financial crisis that develop along two basic paths, first of which involves the mismanagement of financial liberalization/globalization and the second involving severe fiscal imbalances. The emergence of financial crisis in emerging countries originate when countries liberalize their financial systems which is where they eliminate restrictions on financial institutions and markets domestically and open up their economy to flows of capital and financial firms from other nations. Emerging economies typically have weak supervision and a lack of expertise in the screening and monitoring or borrowers by banking institutions. This leads to riskier lending that consequently leads to enormous losses. Eventually all of the high risky lending starts producing high loan losses leading to the deterioration in bank balance sheets and banks cut back on their lending. The second path through which emerging countries experience a financial crisis is government fiscal imbalances that require budget deficits that need to be

If financial institutions in an economy significantly begin to weaken they will start to fail, this in turn can lead to fear within the economy and can be a result of asymmetric information. Institutions that are healthy can also feel the down fall as depositors begin to panic and withdraw their money fearing for the safety of their deposits. The increase in the level of withdrawals will in turn lead to banks failing and cause a loss of information production and a direct loss of banks’ financial intermediation. During a banking crisis, banks would now have less funds to lend, this means that interest rates will increase and in turn borrowing will decrease. Bank panics will increase adverse selection and moral hazard problems which would lead to an even greater decline in banks’ lending hence economic activity and investments would