What is a financial crisis? A financial crisis is a situation wherein the prices of assets witness a steep downfall in value, banks or financial institutions experience the shortage in liquidity and consumers and business are not able to repay their loan obligations. It is associated with a panic during which the investors of money break their savings or take money. The crisis might be restricted to banks. Sometimes, it might spread across a single economy.
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Rajiv Kumar, who is the Vice-Chairman of Niti Ayog, said that the current financial crisis is in India unparalleled and the government has to take steps to manage the current economic slowrun. He further said that the whole economy witnessed major changes and developments after roll out of bigger initiatives such as demonetization, bankruptcy and insolvency code and goods and services tax (GST).
Financial crisis may be clubbed into several types that include balance of payment, currency crisis, sovereign debt crisis, banking crisis, corporate debt crisis and board financial crisis.
See Also: Sub-prime Crisis and Indian Real Estate
Let’s take a look at the financial crisis of 2007 and 2008 to understand the concept better. The financial crisis of 2007 and 2008 is also known as the global financial crisis. It was the severe global economic crisis. It started in the year 2007 with a crisis in the subprime mortgage market in the United State of America and later it developed into a well-blown overseas crisis in the banking sector. The whole financial system was badly hit by the crisis. Business was slow. There were plenty of job cuts.
In 2006, the first sign that the whole economy was in a big trouble. That’s when the prices of houses began to shortfall. The entire real estate industry applauded. They thought that the overheated home loan market shall return to a sustainable level. It was not realized by the realtors that there had been too many owners of the home with doubtful credit. People were allowed to obtain home loans for 100%. The Community Reinvestment Act was blamed by many. It made banking institutions to make investments in the subprime localities. The real villain is the Gramm-Rudman Act. The Act permitted banks to engage in trading profitable derivatives. Financial institutions and hedge funds across the globe bought the mortgage-backed securities. These securities were also in corporate assets, pension funds, mutual funds, etc.
The financial crisis impacts the financial performance of corporate companies. Due to which, there could be job cuts. In the 2008-financial crisis, many Indian and foreign-based companies had sacked thousands of people at all levels. It was a big hit for IT companies and people working in the IT companies. Job cuts leads to liquidity problem among salaried individuals. When the financial performance of the companies is below average or poor, the whole economy of a country, be it India or others, gets imbalanced. Even banks start incurring losses as people start withdrawing their deposits.
As a financial crisis impacts the revenues of companies, the corporate tax collection for the government takes a hit. For any government, tax collections are a major source of income. A poor collection of corporate taxes has a direct impact on the entire economy of a country. If there are no funds, the government cannot allocate any funds for the developmental activities of the country. For instance, the government does not have funds for educational programs, public infrastructure, irrigation projects, etc.
All sectors are likely to be impacted by the financial crisis. In the previous section, we have discussed the impact of a financial crisis on the banking sector. The financial services industry also experiences a massive hit. When people have no funds, they will neither avail a home loan nor a personal loan or property loan. The other industries that are likely to be impacted include the automobile industry, the oil and natural gas industry, the service industry, the transportation industry, the agricultural industry and others.
No country likes to experience the financial crisis. Especially for developing countries such as India and China, it is an indicator of poor economic growth.
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