A financial crisis is a situation where financial institution within a country faces a shortage of funds due to the fall in value of their assets. Most financial crisis happen due to stock market crashes, bank run, bank panic, etcetra.

When banks accept deposits, they use the deposits for making loans in an agreement to get the loan paid back within the specified time. But depositors suddenly withdrawing their deposits lead to a bank run. In some situations, some bank keeps their deposits at other banks. If the first bank is facing a problem of bank run then other bank will also face the same problem. This process of spreading of banking run from one bank to another is known as contagion. This situation can lead to financial crisis.

Looking at the investors it is plain to make investment decisions based on what a bunch of people do. If they think that a bunch of people are going to buy particular assets in expectation that the price will rise in future, they will also start buying, giving a clear indication of a bubble. But they don’t know that along with the bubble there is the possibility of a crash, because investors will keep on buying as long as they expect that the price will increase, but when they decide to sell then the price of that asset will fall leading to a crash.

The latest burning issue these days is the Greece financial crisis. The inability to pay back debts can lead to financial crisis. Apart from the above causes, the slow-down in economic activities for a very long period of time can also lead to financial crisis. The sub-prime mortgage crisis and the great depression are some examples that had happened due to recession leading to financial crisis.

Nevertheless, the financial crisis has also affected Nepal. Citizens living abroad have lost jobs, due to which the remittance has decreased. High revenue mobilisation and negative growth seen in the government’s expenditure is also resulting in contraction in the liquidity position and economic activities are slowing down due to decreasing investment.

The author is research and development manager at Mercantile Exchange Nepal Limited
Preeti Ganeriwal

source: Ganeriwal ,P. (2010),"How financial crisis takes place ",The Himalayan Times, 24 July 2010