A financial crisis is a period in which the financial system becomes severely disrupted. Banks, investors and companies suddenly lose confidence, causing prices to fall sharply and credit to become difficult to obtain. This can lead to bankruptcies, economic contraction and high unemployment.
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A financial crisis often arises from a combination of excessive debt and declining confidence in the market.
In the run up to a financial crisis, households, companies or banks often build up high levels of debt. As long as the economy grows and prices rise, this may not seem like a problem. However, when doubts arise about the ability to repay, for example due to falling house prices or disappointing corporate profits, confidence can quickly shift.
Banks become more cautious in granting loans, investors sell their investments on a large scale and liquidity dries up. This reinforces the decline in prices and can trigger a chain reaction within the financial system. In such situations, governments and central banks often intervene by lowering interest rates or introducing support measures to limit further damage.
Short example:
Suppose banks lend large amounts of money for houses that continue to increase in value. As long as house prices keep rising, the risk appears limited.
When house prices suddenly fall, many homeowners are no longer able to pay their mortgages.
Banks then suffer significant losses, become reluctant to issue new loans and investors lose confidence, pushing the economy into a downward spiral.
Disclaimer: Investing brings risks. Our analysts are not financial advisors. Always consult an advisor when making financial decisions. The information and tips provided on this website are based on our analysts' own insights and experiences. Therefore, they are for educational purposes only.