What You Don’t Know About Bail Out

The banking crisis is having a negative influence on the rest of the economy. Banking crises typically result in severe economic crises with negative GDP growth, recurrent bankruptcies, high unemployment and sometimes social and political instability. The potential collapse of the entire payment system, the flight of capital and the higher possibility of currency crises, and the general lack of trust added to the list. -Read More Here

To prevent the spread of bank insolvencies, bailouts of insolvent financial institutions put a heavy burden on the budget and may raise social inequality by moving capital from taxpayers to depositors. Budget deficits limit potential government expenditure which can contribute to an inflationary monetary policy by imposing an additional inflation tax on taxpayers. By keeping dysfunctional banks alive and thus reducing the motivation of managers to behave efficiently and depositors to select financial institutions carefully, bailouts will distort economic incentive systems, thereby preparing the ground for potential banking crises.

At this point, economists agree that the banking crisis is causing greater losses for developing countries than for developed countries with a well-developed banking system and successful supervisory regimes.Economists refer to the supply of funds to a bankrupt or nearly bankrupt financial institution for the purpose of raising its liquidity and preventing the financial institution’s bankruptcy. Bailouts are typically made by government or private investors who are willing to take over the distressed institution in return for the funds offered.

Moreover, bank failure has a domino effect: there is a possibility that if one bank fails, it could spread to the entire banking system. Depositors of other commercial banks may begin to believe that one bank’s failure is just a start and may create a “bank run” because of false expectations – a situation in which depositors withdraw huge deposits from banks that are marked by long queues in front of the bank offices.