Question

What is a currency crisis and how does it affect the banking system? In what ways do banking crisis crisis speak currency crisis?

Answer 1

A currency crisis is the steep decline in the value of the county's currency which creates an economic imbalance in the country. It creates an instability in the exchange rates and the currency will be no longer be needed as much as it did for exchange purpose before the crisis. The crisis may effect the banks if the policymakers in a pressure to control the currency crisis increase the interest rates. Also, the banks are effected when the banks are taken large exposures of large unhedged foreign liabilities. It can adversely alter the balance sheet by deteriorating its balance sheet. Banking crisis speaks of currency crisis when the banks are borrowed huge amounts of foreign capital and the rest of the world now decides that they have taken too much risk by lending the banks thereby demanding their money back. To repay the money back, the bank utilizes all of its foreign exchange reserves leading to a reduction in the reserves and causing the currency to devalue.