Crises are endemic to modern economies. The term financial crisis refers to a variety of situations in which some financial institutions or assets suddenly lose a large part of their value. Financial crises are common to both authoritarian and democratic societies, and both suffer from crony capitalism of different forms.
Irrespective of location or cause of a crisis what is being done to deal with it remains the same as told by Washington Consensus. In the 19th and early 20th centuries, many financial crises were associated with banking panics, and many recessions coincided with these panics. Other situations that are often called financial crises include stock market crashes and the bursting of other financial bubbles, currency crises, and sovereign defaults.
Financial crises directly result in a loss of paper wealth; they do not directly result in changes in the real economy unless a recession or depression follows. Many economists have offered theories about how financial crises develop and how they could be prevented. There is little consensus, however, and financial crises are still a regular occurrence around the world irrespective of economic philosophies being followed.
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Financial crises are common to both authoritarian and democratic societies, and both suffer from crony capitalism of different forms. Irrespective of location or cause of a crisis what is being done to deal with it remains the same as told by Washington Consensus.
Financial systems have four functions: Resource allocation, price recovery, risk management and corporate governance. The Asian Crisis, the Global Crisis and the recent European Sovereign Debt Crises were excellent examples of how these four functions were not performing well in the concerned Markets.
The resource allocation for a long time had been “policy or state-directed”, which meant the protected banking system providing resources to ‘priority sectors’ such as exports, industrialisation and infrastructure. Korea followed the family-controlled conglomerate or chaebol.
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They enjoyed negative real interest rates. These chaebols were extending loans to loss-making group members to keep the entire group afloat. “Gains were privatised and losses were socialised’, as the state either bailed out the banks out or bailed the conglomerates out. It was a strong but effective nexus between state, banks and conglomerates.
The banks lost the capacity to evaluate more as they provided more credit to large borrowers and ultimately banks lost the independent credit culture. The finance for growth policy gave way to preference to the interest of enterprises rather than savers.
Since the banks were the major source of funding they also became too big to fail. Interestingly, before the Asian Crisis except that of Philippines, and South Korea there was no deposit insurance. Since the banks knew that the state was behind them, they undertook risks that would not have been possible without such backing. Of late, globalisation has led to contagion factor, affecting other economies as well.