Definition
A financial crisis is a severe disruption in financial markets that threatens the solvency of major institutions and the supply of credit to the wider economy. Its typical features include a sharp collapse in asset prices, widespread failure of banks or other financial intermediaries, freezing of interbank lending, and a sudden contraction of credit to households and firms. Financial crises usually trigger or deepen recessions and often require large-scale state intervention to contain.
The pattern recurs across centuries and continents: the Dutch tulip mania (1637), the South Sea Bubble (1720), the panics of 1873 and 1907, the 1929 crash, Mexico 1994, East Asia 1997, Russia 1998, the global crisis of 2008. Each has unique features, but the underlying anatomy — speculation, leverage, sudden reversal — is remarkably stable.
Why it matters
How it works
A typical financial crisis follows a recognisable arc. A period of low interest rates and rising asset prices encourages borrowing to buy assets that are themselves rising in value — leverage builds across the financial system. Some event (a default, a policy shift, a fraud revelation) triggers a reassessment of risk. Asset prices fall. Highly leveraged investors must sell to meet margin calls, pushing prices down further. Banks holding the assets become insolvent or appear so. Lenders pull money from banks even when they are solvent, fearing they might not be. Credit freezes; firms cannot borrow; the real economy contracts.
Financial integration amplifies this internationally: assets held abroad are sold, currencies of the country in crisis collapse, banks in other countries that lent or held exposures take losses, and the cycle propagates outward.