Financial crises have multiplied in the 1990s successively affecting the so-called emerging countries. The crisis experienced by Mexico in 1994, Asia in 1997, Russia in 1998 and Brazil in 1998 and 1999 are still fresh in the memory of economists and people in these countries. The impact of all these crises on the real economy has been significant, as they have all caused deep recessions.
[...] In addition to facilitating action on information it can also act for the prevention of financial crises by regulation. It can be externally driven by monetary authorities who then set the rules of liquidity, solvency, risk division, deposit insurance, etc or be regulated internally within institutions. Prudential regulation involves encouraging banks and other financial market participants to recognize their risks and enabling authorities to monitor the currents that threaten the stability of the system and correct them. This is to stop the players from playing "all out" and taking unnecessary risks. [...]
[...] While the long-term capital investments are essential to growth, but short-term ones give rise to volatile exchange rates the influence interest rates, thereby multiplying the risk of financial crises on three levels. Firstly they may cause a crisis of balance of payments if the external debt becomes too large compared to the national economy. Secondly they may cause a liquidity crunch, in case of excessive short-term external debt relative to liquid foreign assets. Finally, a domestic banking crisis cannot be avoided in cases where national banks have borrowed in international currency and loaned in local currency. [...]
[...] It will be interesting to study the first time that two types of hazards are combined, posing a serious risk of financial crises, against which it is difficult to fight. In the second step, we will study the effects of liberalization and of international capital flows, on the possibility of financial crises, as well as ways to mitigate these effects. Two types of hazards are sometimes combined, posing a serious risk of financial crises which can hardly fight purely economic risks. [...]
[...] During the 1990s, advances in financial engineering were used to invent ways to borrow as much as possible without spending an equivalent amount towards improving the transparency of these loans. Increased borrowing has the potential to increase the capacity of leverage, which characterizes a situation where the economic profitability of a business exceeds the cost of its debt. More opportunities to borrow therefore provide more opportunities to take advantage of debt and leverage. The problem arises as companies are more inclined to use that money on risky ventures that are not their own. [...]
[...] The last condition is the establishment of government guarantees of solvency and liquidity of the financial and monetary system, and the presence of a lender of last resort. These conditions are usually fulfilled within each country and integrated into a common currency like the euro area, but may not be fulfilled at the international level, which is where the crisis now exists. It is nevertheless possible to regulate them. Intervention may occur at two levels: before the crisis to prevent it, or after the spread of the crisis. [...]
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