A financial crisis can be defined as anything that disturbs the smooth functioning of financial markets. The inception of a financial crisis begins with falling asset prices and bankruptcy of debtors and investors leading to inefficiencies in capital allocations in markets. This gradually spreads through the entire financial system resulting in collapse of the entire financial structure of a nation. The main reason for a crisis to come up in the economy is that the banks are able to create too much of money than that is required and this excess money is used to push up the property prices and create speculation in the financial markets. Once speculation is used in an extreme manner in the financial markets it is a general sign of an economic downturn or a crisis situation. Let us explore the reasons for a financial crisis to take place.
Money creationThe first reason is that money creation process of the banks. It is a fact that each time a bank extends a new loan it creates additional money to the market and that amount is also multiplied due to the credit creation ability of the banking system. Just before a financial crisis usually the property prices and usually the immovable assets prices shot up drastically and credit is made available by many banks and financial institutions in the form of loans and mortgages. Buyers agent in Melbourne make best use of this situation to raise the prices of the assets and create speculation within the real estate market to earn larger profits. This ultimately leads to a collapse in the entire financial system.
Debts fall dueAt a certain point all these increases in asset prices comes to an end and the artificial bubble that was created around the immovable property market bursts and the prices begins to fall. The speculators and property managers who purchased land with the intention of a higher rate have to abandon all hope on earn huge profits by property managers in Brighton. As a result, the loans obtained to purchase the fixed assets fall due resulting in severe liquidity problems within banks and financial institutions.
CrisisThis is where the economy walks into a financial crisis of falling financial markets and financial disintermediation. Some banks may fail while others make losses and somehow manages to do business depending on government backing. The economy starts to shrink as banks are unwilling to lend as the credit worthiness of the customers are very low. As the banks refuses to lend new loans, the economic activities of the country are disturbed. But however the repayments are to be made. And economists see this repayment of loans as a means of “destroying” money.