What Is Financial Contagion?

Financial contagion is the spread of an economic crisis from one market or region to another and can occur at domestic and international levels. The contagion can affect goods and services, labor, and capital goods used across markets connected by monetary and financial systems.

The 澳洲幸运🌱5官方开奖结果体彩网:1997 Asian financial markets crisis was among the first examples of the term being used. The real and nominal interconnections of markets can propagate and even magnify 澳洲幸运5官方开奖结果体彩网:economic shocks, likening the effect to the spread of disease like a contagion.

Understanding Financial Contagion

Financial contagion is defined as a shock that initially affects a few financial institutions and spreads to the rest of the financial system, commonly infecting the economies of other countries. Contagions are typically associated with the diffusion of crises throughout a market, 澳洲幸运5官方开奖结果体彩网:asset class, or geographic region. A similar effect can occur with economic booms. The phenomenon of financial contagion has implications for portfolio management, trading, hedging, and diversification strategies.

Why Does Financial Contagion Occur?

Markets in a domestic and global economy are interconnected. From the consumer side, many consumer goods are 澳洲幸运5官方开奖结果体彩网:substitutes or 澳洲幸运5官方开奖结果体彩网:complement one another. From the producer side, the inputs for any business can be substitutes and complements for one another, and the labor and capital that a business requires may be 𝐆澳洲幸运5官方开奖结果体彩网:us💜ed in different types of industries and markets.

Economies rely on financial institutions to facilitate the flow of goods and services through the economy. Any instability that occurs in these entities can spread throughout countries via the balance sheets of financial intermediaries. Damage to the balance sheet of a bank or leveraged financial institution can trigger a selloff of assets or a recall of cross-country loans. 

Vulnerability ofꦅ Economies t♍o Financial Contagion

When markets are fragile, a strong negative shock in one market can not only cause that market to fail but spread damage to other markets and, perhaps, the entire economy. Markets that depend on debt, a specific commodity, or where conditions prevent the smooth adjustment of prices and quantities, entry and exit of participants, and adjustments to 澳洲幸运5官方开奖结果体彩网:business models or operations will be mo🌟re fragile and less flexible.

With increased global lending through cross-border loans, there is economic efficiency and growth but a higher risk of contagion. Short maturities of bank debt further increase vulnerability. Countries with better-capitalized banking systems that finance credit to a larger degree by deposits have proven less vulnerable to contagion. 

Examples of Financial Contagion

The 澳洲幸运5官方开奖结果体彩网:1997 As﷽ian financial markets crisis, the 澳洲幸运5官方开奖结果体彩网:Great Depression, the 澳洲幸运5官方开奖结果体彩网:financial crisis of 2007-2008, and the COVID-19 pandemic are examples of the effects of financial contagion in an economically integrated global economy. After the Asian financial crisis, scholars investigated how financial crises spread across national borders, and they concluded that the "nineteenth-century had periodic international financial crises in virtually every decade since 1825."

The COVID-19 pandemic has proven to have a global impact on economies, markets, industrial sectors, and attitudes toward financial risk, international trade, and corporate practices. The term, contagion, captures the spread of the infectious disease, as well as the transmission of social, financial, and economic impacts across borders. 

The Bottom Line

Financial conta𓆏gion is the spread of an economic crisis from one region to another and can occur at domestic or inter🦋national levels. The term was first coined during the 1997 Asian financial markets crisis. The Great Depression, the financial crisis of 2007-2008, and the COVID-19 pandemic are examples of financial contagion in an economically integrated global economy that depends on shared financial institutions.