Financial crisis Essay Example | Topics and Well Written Essays - 500 words

Financial crisis - Essay ExampleComp ared to the traditional savings deposit, this 3% is way higher which explains wherefore a lot of depositors and investors put their capital in WMPs. The reason why WMPs have higher touch on yields is because they are fasten up with riskier bank loans of intermediaries. WMPs are also not held in banks balance sheets which means that that there are no capital set aside for them during defaults.Shadow banking creates a vicious cycle because intermediaries or trust companies also loans discover to a companies which in turn merchantman also deposit back to a bank which will again transfer it to an intermediary. Such money will again be recycled except that a certain portion of it held through the mechanism of RRR or reserve requirement ration (which is really just liquidity ratio) which is portion of the loan that must be withheld from loaning out.This cycle is vicious because a $10 deposit can be loaned for $8 to another(prenominal) company whic h can again deposit it to a bank which will again loan it out for $6.4 where the same amount diminishes in the cycle. In the process, the investor is guaranteed a 3% return for the deposit.This kind of banking is not sustainable in the pine run. Shadow banking in China is US equivalent of character reference swap which is tied up to riskier loan. In Chinas shadow banking, WMPs are tied up intermediaries riskier loans which are not registered in companys balance sheets and therefore not backed up by capital in case of default. In the US, acknowledgement swaps are credits lumped together with riskier loans such as subprime mortgage and then sold to another entity. The principle are the same except that US credit swap is riskier to Chinas shadow banking which only guarantees a 3% return on WMPs credit swap contains subprime loans that are almost certain to default. This shows that both system is not sustainable in the long run because of the risk involved and the investments not gua ranteed by capital for potential