Banking crises can lead to systemic risks from "summary" of Economics of Money, Banking and Financial Markets, Business School by Frederic S. Mishkin
Banking crises have the potential to trigger systemic risks within the financial system. When a banking crisis occurs, it can have far-reaching effects beyond just the individual bank experiencing difficulties. The interconnected nature of the financial system means that problems in one institution can quickly spread to others, leading to a domino effect of failures. One of the key reasons why banking crises can lead to systemic risks is the concept of contagion. Contagion occurs when problems in one bank or sector of the financial system spread to other banks or sectors. This can happen through various channels, such as interbank lending, asset fire sales, or a loss of confidence in the financial system as a whole. Another reason why banking crises can pose systemic risks is the potential for liquidity problems to escalate. If a bank experiences a run on deposits or is unable to access funding in the interbank market, it may be forced to sell assets at fire-sale prices. This can lead to further losses for other banks holding similar assets, creating a vicious cycle of contagion and instability. Furthermore, banking crises can also have real economy effects, such as a credit crunch or a contraction in lending. When banks are in distress, they may become more risk-averse and reluctant to extend credit to households and businesses. This can dampen economic activity, leading to higher unemployment and lower economic growth.- The interconnected nature of the financial system means that problems in one part of the system can quickly spread and amplify, creating systemic risks that have the potential to destabilize the entire financial system. It is essential for policymakers and regulators to be aware of these risks and take proactive measures to prevent and mitigate banking crises to safeguard financial stability.
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