Question

In the book "The Shifts and the Shocks" by Martin Wolf, of Chapter 4 How did finance become fragile? What was the reason?

Answer 1

Dear Student,

Below is the reason for financial fragility

1) Poor fundamentals of the economy - which make it vulnerable during a time of duress such as a recession

2) Banks serve as intermediaries - between depositors and borrowers.  Depositors want immediate access to their deposits, while borrowers are not able to pay on demand.his creates a fundamental fragility, as a bank's assets cannot be liquidated in the event of a crisis to pay all depositors. This tension makes the financial system susceptible to a sudden change in demand for money by depositors, resulting in a bank run

3) commitment device - Under this view, depositors would not normally trust banks with their deposits because they fear that when they want to withdraw their money, the bank may try to avoid repaying, or try to repay at a lower rate. However, if the bank does not have enough liquid assets to cover all depositor claims, a refusal to pay any one depositor the promised amount will prompt all other depositors to try to withdraw as well, and effectively cut off all lending to the bank

4) portfolios of investors - If investors have linked portfolios such that if one investor withdraws funds the investment will fail and the other investor will also take a loss, then any event that causes investors to change their portfolio could cause others to take losses.

Thank You !!