One avenue by which a loss of confidence in one financial institution spreads to another financial institution is through:
A) a steep decline in asset prices driven by fire sales to restore liquidity.
B) a sharp decline in interest rates to compensate for added risk.
C) an increase in government deposit-insurance coverage.
D) a rapid slowdown in the withdrawal of deposits.

Question

Quizplus · Accepted Answer

If one financial institution experiences a loss of confidence, investors or depositors may sell off assets in an effort to regain liquidity. This can drive the price of those assets down, affecting the balance sheets of other financial institutions that hold similar assets. As a result, these institutions may also experience a loss of confidence, making it harder for them to borrow and potentially leading to a wider crisis.

One Avenue by Which a Loss of Confidence in One