Cause, Impact and Policy of Banking Crises Banking Crisis Asst. The former involve a sudden movement of the exchange rate and sharp change in capital flows. Financial crises normally originate in or induce insolvency in the banking system and feature a collapse in asset prices, most often in equity and securities market. Financial crisis usually involves a corporate debt problem in the non-bank financial sector. In other word, banks and other intermediaries usually do not get into trouble if borrowers can easily service their debt.
Financial crisis can occur without any currency crisis.
Mild currency crises usually involve neither a corporate debt problem nor a banking crisis, as in the case of the 1992 ERM episode, whereas severe currency crisis usually do trigger on or both. That is, severe currency crisis usually entail a crisis in the banking and non-bank sectors. They find that exchange rates of the term of trade are not that significant in explaining the financial crisis. Slower output growth, increases in real interest rates, declining liquidity, faster credit growth, explicit deposit insurance, poor legal systems, and low per capita GDP are found to be factor contributing to banking crises. Over optimistic of economic development lead to loose credit decisions and very high debt -equity ratio, resulting very high leveraged risk.