Question

Define, diagram and then explain the three stages of a banking crises.

How does asymmetric information and moral hazard play a role?

Answer 1

Stage 1: Initiation of financial crisis in which the symptoms are visible and largescale jeopardy and stock prices crash alongwith multiple pendulum swings and market volatility.

Stage 2: Onset of financial crisis here banks default and full blown crisis surfaces and lead to stock market bottoms, heavy unemployment, low volatility and subdued demand

Stage 3: Debt deflation here GDP falls tremendously and long run effects are ibserved with deflation and high debt, stock makret volatility with new government intervention schemes and central bank vigilance.

Assymetric information by empoyees of banks cause triggered recession as the background check is uncertain and largescale institutional buyers are given loans who have high debt and low credit rating.

Moral hazard causes customer to get protected agaunst risks of banks getring default as per central bank norms and thus heavy debt rises for banks as CRR and SLR is liquidated.

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