Financial crisis
A sudden loss of value in financial assets.
A financial crisis occurs when various types of financial assets abruptly lose much of their stated value. When this leads to a wider slowdown in economic activity that impacts the entire economy, it is called an economic crisis. During the 1800s and early 1900s, financial crises often involved banking panics, and many recessions happened at the same time as these panics. Other events labeled as financial crises include stock market crashes, the collapse of speculative bubbles, currency crises, and governments failing to pay their debts. These crises directly cause a loss of wealth on paper, but they do not always lead to major changes in the real economy—for instance, the famous tulip mania bubble of the 1600s did not have such effects.
Many economists have developed theories about how financial crises start and how they might be prevented. However, there is little agreement among them, and crises still happen from time to time. One clear pattern is that economics and applied finance consistently fail to predict and stop financial crises. This raises questions about what is actually known—and what can be known—in these fields. Some argue that the assumption of simple, clear cause-and-effect relationships in economic thinking, models, and data may partly explain why financial crises often seem built-in and unavoidable.
**Types**
**Banking crisis** A bank run happens when many depositors suddenly try to withdraw their money at once. Because banks lend out most of the cash they receive (a system called fractional-reserve banking), they cannot quickly repay all deposits if demanded. This can make the bank insolvent, causing customers to lose their deposits unless they are protected by deposit insurance. When bank runs become widespread, it is called a systemic banking crisis or banking panic. Examples include the run on the Bank of the United States in 1931 and the run on Northern Rock in 2007. Banking crises usually follow periods of risky lending and resulting loan defaults.
**Currency crisis** A currency crisis, also known as a devaluation crisis, is often considered part of a financial crisis. Some researchers define it as occurring when a weighted average of monthly exchange rate depreciation and monthly declines in foreign exchange reserves exceeds its average by more than three standard deviations. Others define it as a nominal currency depreciat
- type
- Economic phenomenon
- key_types
- Banking crisis, currency crisis, speculative bubbles and crashes, international financial crisis, wider economic crisis
- notable_examples
- Dutch tulip mania, South Sea Bubble, Wall Street crash of 1929, Japanese property bubble of the 1980s, United States housing bubble crash 2006–2008
- common_causes
- Strategic complementarities, leverage, self-fulfilling prophecies
- associated_terms
- Bank run, recession, depression, sovereign default, devaluation
Lore & Background
Financial crises have occurred throughout history, with notable examples including the 17th century Dutch tulip mania and the 18th century South Sea Bubble. In the 19th and early 20th centuries, many financial crises were associated with banking panics, where a sudden rush of withdrawals by depositors rendered banks insolvent. The Great Depression was preceded in many countries by bank runs and stock market crashes. Banking crises generally occur after periods of risky lending and resulting loan defaults.
Reader's Guide
Financial crises are significant because they directly result in a loss of paper wealth and can lead to wider economic crises such as recessions or depressions. Many economists have offered theories about how financial crises develop and how they could be prevented, but there is little consensus and financial crises continue to occur. A consistent feature is the inability to predict and avert financial crises, raising epistemological questions within economics. The phenomenon of reflexivity, where investors' expectations become self-fulfilling, poses a challenge to traditional causal models. Leverage, or borrowing to finance investments, magnifies potential losses and is frequently cited as a contributor. While some crises have limited real-economy impact, others, like the subprime mortgage crisis and bursting of real estate bubbles, have led to widespread recession.
Did You Know?
- Financial crises directly result in a loss of paper wealth but do not necessarily result in significant changes in the real economy.
- Banking crises generally occur after periods of risky lending and resulting loan defaults.
- A speculative bubble exists in the event of large, sustained overpricing of some class of assets.
- Some economists argue that financial crises are caused by recessions instead of the other way around.
More in Finance And Investment 1-24
Spotted an error? Know more?
This is a living reference — every entry is fact-audited, and reader corrections feed straight into our audit queue. Suggest an edit · See this site's audit record